How to Get Through a Stock Market Crash

How to Get Through a Stock Market Crash

Should You Sell Your Stocks in This Market?

Another year, and another stock market crash. It may seem that in recent years the volatility of the market gives us more sharp rises and subsequent crashes, but in the end these market cycles have played out for decades to varying degrees. Every crash has its catalyst, which makes each one a little different‒whether it’s a Black Friday event, a dot-com bubble bursting, a fat-fingered trade, or real estate and credit crisis, there’s always something to blame. This is also why people love to say that “this time is different.” Sure, the reason the market went down might be different, but the basic mechanics of how the markets work remain the same.

Here we are on the heels of the “Great Recession” where markets plunged around 50 percent, and the following two years ended up being the best two-year period in the history of the stock market and stocks rebounded and doubled in value. Today, a continued weak economy, high unemployment, and now a downgrade by S&P on U.S. debt has sent the market into another tumble, the worst we’ve seen since 2008. Just when things were looking up, our portfolios are again humbled. So what is an investor to do during another stock market crash?

Don’t Panic

Above all else, don’t panic. I know, easier said than done, but this is one of the downsides of technology. Today we are wired to the news and our finances 24/7. If you’re on Twitter when the market is tanking you’re bombarded with unsettling messages. If you’re checking Facebook you see your friends complaining about their investments. If you watch the news, be prepared to curl into the fetal position and just start sobbing thanks to the over-the-top reporting. We can’t escape the news, and that’s part of the problem.

Years ago investors didn’t have this “luxury.” One would think that being on top of the markets and your money would be a good thing, but in fact it is just the opposite. Being flooded with headlines all day, every day, just means you’re constantly thinking about it and you could end up making a hasty decision. In the past you basically relied on your quarterly reports which meant you saw a progress report just once every three months. Your portfolio could have dropped 10 percent and subsequently regained all of that in the span of one quarter and when you got your statement you wouldn’t even know what happened and would be satisfied you didn’t lose any money over the past three months. Today, you’re getting text alerts and pulling up your portfolio on your iPhone 50 times a day, giving you a chance to react to the news on a by-the-minute basis instead of going weeks or months without knowing what’s going on. That is a recipe for disaster.

So first things first: unless you’re a day trader or manage other people’s money, unplug from the financial news a bit. It’s good to stay informed, but if you’re gawking at your phone every 20 minutes at work wondering what the market is doing, you’re only stressing yourself out and likely going to make an investing mistake. If you are still worried about your investments it’s time to step back and look at the big picture.

The Big Picture

It’s easy to get wrapped up in the media hype of a significant market rally or crash. Just a few days of good or bad news can send the market into a frenzy one way or the other. When this happens it isn’t uncommon to feel as if you’re missing out if you aren’t doing something to take advantage of the news. Resist the urge to act on impulse to this short-term news. Instead, it’s time to take a look at the big picture, your long-term objectives, and then determine if anything needs to be done.

For example, if you’re looking at just a two week period when the market started to crash, the picture is frightening. It looks like you’re falling off a cliff and there’s no end in sight.

It’s all about context. While there are obviously short-term bad periods, the opposite is also true. Take this example from late last year. We had a significant rally and the news was praising the recovery and talking about how great everything was going. If you were looking at your year-end investment statement you were probably quite happy.

As you can see, depending on what you choose to focus on you can see both very good and very bad when it comes to short timeframes. A few bad weeks or months and all you can see is red, but a few good months has you licking your chops wanting even more. But what happens on a week-to-week, or even month-to-month basis has little to do with your big picture.

Clearly, what happens today, this week, or even this year has a minimal impact when you’re likely looking at 30 or more years. Sure, in the short-term these swings can make you sick to your stomach of jump out of your chair in joy, but all said and done these periods of time are just a tiny snapshot of what you’re ultimately trying to accomplish. For example, let’s look back to 2003. As you can see, the past eight or so years has been a bumpy ride, but what happened in the past week hardly registers on the chart.

Then let’s go back even further, covering the past 15 years:

And finally, let’s look at a 30-year time frame, which is what many people are looking at in terms of their investment horizon:

Clearly, the greater the length of time you’re looking at, the less significant daily, weekly, or even monthly activity seems to have. Sure, what happens on a day-to-day basis will impact your bottom line, but if you step back and look at the forest for the trees you can alleviate much of your short-term anxiety.

Stick to the Basics

Even after looking at the big picture it’s easy to forget the basics. We’ve all heard the same advice year after year: invest regularly over time, create a diversified portfolio, and rebalance your portfolio. It sounds simple enough, yet we rarely follow through. It’s a shame, too, because it does work. In fact, I wrote about this in great detail in my piece about the lost decade of investing. The 2000s were a notoriously bad year for stocks and it’s been dubbed the ‘lost decade.’ That’s because over those ten years the broad stock market generally saw either no gain at all, or even lost money. That’s a far cry from the long-touted 8-12% annual returns. Even though the media likes to point out the indicies didn’t make money over the decade, I’ve shown that real world investors who stuck to the basics still came out ahead. Here’s what I’m talking about. If you were to put your money into stocks and let it ride for the next ten years, you would have actually lost money:

But wait a second. Even though stocks had one of the worst ten-year periods in history, if you continued to invest regularly over time in a diversified portfolio and rebalanced regularly, you actually made a respectable return while the indicies lost money, and most investors lost even more trying to time the market based on fear. Here’s what happened over that same time period above, and with the same amount of money invested, but following the tried and true advice:

That’s the power of dollar-cost-averaging. Sure, the market might be tanking, but guess what? If you’re still putting money into your 401(k) or IRA every two weeks from your paycheck you’re actually buying into the market at low points. This means when the market does turn around, you are fortunate enough to have some of that money invested at historically low points where the future gains can be quite high and then offset the losses you incurred elsewhere.

This method of investing isn’t just a textbook exercise. It’s promoted to this day because it works. The real problem is sticking to it. And nobody is arguing that in theory you could make far more money if you happened to make a lump-sum investment at the absolute bottom of a bear market and then sell after the rally, because on paper that’s true. But since we can’t predict the future, trying to pull your money in and out of stocks based on instinct or historical performance is no better than going to the casino and betting red or black on roulette based on what the past numbers have been. If you take luck out of the equation and invest consistently over time, into a well-diversified portfolio, and rebalance regularly, you’ll almost always come out ahead of the pack.

Taking Additional Measures

Even if you’re doing everything right there are still times when a prolonged bear market can take its toll on your finances. First, assess your situation. If you’re invested so heavily in stocks that the daily market fluctuations make you sick to the stomach or cause you to lose sleep, you need to think about investing differently. Seriously, no investment is worth reducing your quality of life due to worry and stress. If this is you, then maybe it’s time to create a more conservative portfolio and be satisfied with lower, but more consistent returns over time.

There’s nothing wrong with that and everybody has a different risk tolerance. So don’t think that just because you’re 35 years old you need to put 85% of your money into stocks. If you aren’t comfortable with that, don’t do it. But also have realistic expectations that you will inevitably miss out on future bull markets and be confined to more modest returns. The worst thing you can do is pretend to get conservative in a down market and then decide you’re willing to take on more risk when things are doing well. That’s a recipe for disaster because you almost always end up selling low and buying high. That’s why most people can’t make money in the stock market. So, develop an investment plan and stick to it through thick and thin.

Also, when the market is down you want to pay extra attention to your liquid assets. When stocks are down it usually means the economy is weak, unemployment is high, and there’s just a general uncertainty in the air. That means it pays to have that safety net in place. Whether it’s an emergency fund in a savings account, a few CDs at the bank, or whatever the case may be, it pays to have cash on hand in times like these. You may not need to tap into it, but with so much uncertainty in markets like these it may be very difficult to obtain credit if you need it in a pinch, and worse yet, if something comes up and you are forced to borrow from your 401k, the withdrawal at a historically low point will just make matters worse. So keep that cash on hand, even if it means putting a little less away for retirement.

Lastly, and this isn’t for the risk-adverse, but consider putting money into things that create a positive return even when the market goes down. That could mean putting a little extra money into bonds, paying additional on your mortgage or other debt, or even investing in things that go up as markets go down.

All of these have their downsides. When you prepay on debt you get a guaranteed savings, but that return could be less than you could get if you were to continue investing. The same is true for investing in bonds. Yes, they are safe and pay regular interest, but if the market turns around quickly and tacks on 20 percent in just a couple of months you could miss the ride. And of course investing in short ETFs or speculating in commodities is not something recommended for long-term investors, but if you’re an active trader and have some speculative money burning a hole in your account, then betting the market will continue to go down could yield a positive return.

Putting it All Together

There is no denying that watching thousands of dollars vanish from your investment account overnight is unsettling. No matter how many times people tell you to stay the course and things will eventually recover, you’re bound to have second thoughts about your investments. So I’m not here to say the same thing, but instead just trying to illustrate that over time things do generally improve, and if you do stick to the basics of investing you can fight many of the downsides that a bear market brings. And ultimately, if you truly are unable to weather the storm, it is ok to change your investment strategy. But if you do, you have to stick with that strategy through good times as well as bad because the worst thing you can do is continuously alter your investments based on the prevailing winds in the market. Without being able to see the future you’ll almost always come out behind using this strategy unless you’re lucky.  But if you invest properly, keep your safety net in place, and continue to look at the big picture, you will get through this and any future stock market crash just fine.

Author: Jeremy Vohwinkle

My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.

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