What To Do When The Market Crashes?

Since the beginning of 2022, crypto and stock markets have been very volatile due to fears about increasing inflation and interest rates. The S&P 500 entered a bear market on May 20, down 20% from its most recent record high, and the Dow Jones Industrial Average was poised for an eight-week losing run. 

Although the past can tell us how long crashes, stock market corrections, and bear markets normally persist, no one receives a calendar notice indicating the timing, type, and expected severity of future drops. 

When the stock market falls, and the value of your portfolio drops dramatically, it is tempting to question yourself or your financial adviser (if you have one): “Should I withdraw my money from the stock market?” This is understood but is most likely not the optimal course of action. Instead, you may want to inquire, “What should I not do?”

What Should You Be Doing? 

The solution is straightforward: Do not panic. When stocks plummet, and the value of their portfolios plummets dramatically, panic selling is often the first response of investors. Determining your risk tolerance and how price variations — or volatility — will influence you is crucial. You may also limit market risk by hedging your portfolio via diversification, which involves owning a range of assets, including ones with minimal connection to the stock market. 

What Exactly Is A Market Crash?

The most recent market catastrophe occurred in the beginning of 2020. While no exact number signals a collision, some information is provided below. The S&P 500 stock index fluctuates between -1 percent and 1 percent on any given day. Anything outside of these criteria may be deemed a busy day on the stock market – for better or worse. 

If the S&P 500 falls 7% in a single trading day, trade may be paused for 15 minutes. This has only occurred a few times in the history of the market, and it is truly a very horrible day for Wall Street. A crash is characterized by a dramatic and unexpected decline in stock values, which often follows an ascent in the stock market, also called a bull market.

Why Shouldn’t I Be Panicking?

Investing enables you to secure your retirement, maximize the use of your savings, and increase your wealth via the power of compounding. Therefore, 44% of Americans do not invest in the stock market, according to a Gallup study conducted in July 2021? 1 Gallup hypothesizes that this is related to a loss of trust in the market due to the financial crisis of 2008 and significant market volatility over the last year. Additionally, people without adequate resources to sustain themselves month-to-month often lack the funds to invest in the market. 

According to Gallup, from 2001 to 2008, an average of 62 percent of U.S. adults held stock, a figure never attained since. A drop in the stock market owing to a recession or an exogenous occurrence such as the COVID-19 pandemic may put fundamental investment principles such as risk tolerance and diversification to the test. Remember that the market is cyclical and that falling stock prices are inevitable. However, a recession is transient. When stock prices are low, it is more prudent to look long-term than to sell in a panic. 

Long-term investors are aware that the market and economy will ultimately recover and should position themselves accordingly. The market fell during the 2008 financial crisis, and several investors liquidated their assets. However, the market bottomed out in March 2009 and gradually returned to and surpassed its prior heights. Sellers in a panic may have lost out on the market’s ascent, but long-term investors who stayed invested ultimately recovered and performed better over time. 

In March of 2020, when the stock market entered a bear market for the first time in 11 years due to the economic effects of the worldwide pandemic, the S&P 500 dropped by a gut-wrenching 35 percent over the course of a little over four weeks. Not only did the index recover rapidly from those lows, but it has also reached many record highs since then. 

Develop a bear market plan to save your assets instead of panicking and locking in your losses by selling at the market’s lows during a severe market correction. 

Has This Happened Before? 

Even though the stock market has ups and downs, stock market collapses are not that often. Several of the most significant U.S. stock market collapses of the last century include: 

  • 1929 saw a precipitous decline in the stock market in reaction to a weakening economy and investor fear, signalling the beginning of the Great Depression. The market reached its lowest point in 1932, more than 80 percent below its all-time high, and it took over two decades to recover. 
  • On “Black Monday” in 1987, the market fell 25 percent due to market downturn, investor fear, and early computerized trading has gone wrong. The market rebounded within two years, and the Securities and Exchange Commission established trading restrictions and circuit breakers to avoid panic selling. 
  • In March of 2000, the Dot-Com Bubble burst, after a boom of investment and speculation in internet-related enterprises throughout the 1990s. Seven years were required to recover from the S&P 500’s roughly 50 percent decline. 
  • The S&P 500 lost over half its value in 2008 due to the housing bubble and subprime mortgage crisis, and it took two years to recover.  
  • As COVID-19 spread internationally in February 2020, the market declined by more than 30 percent within a month. By August 2020, though, the market had already recovered, taking six months. 

The bottom line being the markets usually recover! 

How Can I Prevent Losses

Here are three measures you may take to avoid making the most common error when the stock market declines.

Recognize Your Risk Tolerance

Investors may likely recall their first encounter with a market decline. A sudden drop in the value of novice investors’ portfolios is disturbing to say the least. When constructing your portfolio, it is crucial to understand your risk tolerance in advance, not when the market is in the midst of a downturn. 

Your risk tolerance is determined by many variables, including your investing horizon, monetary needs, and emotional reaction to losses. Your replies often determine it to a questionnaire; several financial websites provide free online quizzes that may give you a sense of risk tolerance. 

Before investing, you may get insight into your response to market losses using a stock market simulator. With stock market simulators, you may invest $100,000 worth of virtual capital and experience the stock market fluctuations. This will allow you to evaluate your risk tolerance. 

Important in assessing your risk tolerance is the time horizon of your investments. For example, a retiree or someone approaching retirement would likely wish to maintain their assets and earn income in retirement. These investors might invest in low-volatility equities or a portfolio of bonds and other fixed-income products. However, younger investors may invest for long-term gain since they have enough time to recover from bear market losses. 

Plan for and limit Your Losses

To invest intelligently, you must understand how the stock market operates. This allows you to evaluate unanticipated declines and choose whether to sell or acquire more. 

Ultimately, you should be prepared for the worst-case scenario and have a good plan to mitigate your losses. If the market falls, investing just in stocks might lead you to lose a considerable amount of money. To hedge against losses, investors make alternative investments deliberately to lessen their exposure and risk. 

Lowering risk entails a risk-return tradeoff, whereby the decrease in risk diminishes the possibility for earnings. Diversifying your portfolio and using other assets, such as real estate, that may have a low connection to stocks may mitigate downside risk to a significant degree. Diversification consists of having a portion of your portfolio invested in stocks, bonds, cash, and other assets. Depending on your risk tolerance, time horizon, objectives, etc., you will allocate your portfolio differently based on your own circumstances. A well-executed asset allocation plan will help you avoid the risks associated with putting all your eggs in one basket.

Concentrate on the Long Term 

Reams of research demonstrate that while stock market returns may be highly volatile over the short run, equities outperform almost every other asset class over the long term. In the context of the market’s long-term rising tendency, even the most significant declines seem to be minor blips over a suitably enough time frame. Especially during turbulent moments when the market is in a considerable downturn, this aspect must be kept in mind. 

Having a long-term perspective will also allow you to see a significant market decline as a chance to develop wealth by increasing your holdings instead of a danger that would wipe away your hard-earned money. During big bear markets, investors sell equities regardless of quality, offering a chance to purchase certain blue chips at reasonable prices and valuations. 

Consider dollar-cost averaging if you’re afraid that this strategy may resemble market timing. Using dollar-cost averaging, the expense of holding a certain investment or asset, such as an index ETF, is spread out over time by buying the same dollar amount of the investment at regular intervals. Due to the regular nature of these periodic purchases, as the asset’s price varies over time, the final effect may be a cheaper average investment cost.