Early in 2020, the global stock market began heading into bear market territory as the coronavirus pandemic began. market downturns are always a shock, but this particular downturn was even more so because it followed the longest bull market in us. history. The last time stocks experienced such significant downward volatility was in 2008 during a financial crisis that was later dubbed the Great Recession.
united states the federal reserve responded quickly by cutting interest rates and stimulating economic growth through quantitative easing.
Between the Federal Reserve’s monetary policy changes and the stimulus checks, the economy and the market began to reflect the Roaring 20’s. Nothing seemed impossible in the market. But those moves began to fizzle out in 2022. Excess demand produced the highest levels of inflation the country has seen in decades. As the Federal Reserve worked to reduce it, the market tanked, and the S&P 500 was down more than 20% by mid-June.
How should investors respond to a market downturn?
what to do when the stock market crashes
Market downturns are scary events. it’s hard to watch his anger subside as he listens to financial media commentators play out best and worst case scenarios, with neither sounding much better than the other.
The first thing you should do is relax.
This isn’t the first time the stock market has crashed, and it won’t be the last. According to the convention’s wealth advisors, the S&P 500 has fallen more than 20% 12 times since 1950.
That means that over the last 72 years, there has been a significant reduction in the us. uu. market every six years on average. every time it happens, the market recovers and people finally get on with their normal lives.
But what should you do in the meantime? Here are some tips on what actions to take when the stock market crashes.
1. stick to your investment strategy
A sound investment strategy isn’t just designed for you to use during bull markets; it’s designed to protect you while the bears get to you too. You shouldn’t have to abandon your strategy when stock prices start to drop.
Instead, continue to follow your strategy and let the built-in protections work.
However, you may want to make minor adjustments to your asset allocation strategy. That’s especially the case if you have a cyclical stock portfolio. consider taking a more bearish stance by increasing your safe haven allocation and adjusting your stock allocation towards a large dose of non-cyclical stocks such as health care and utilities.
2. don’t be afraid to sell
Panic selling is the first reaction many have to market downturns, especially beginning investors. Seasoned long-term investors know that panicking is not the answer.
Sure, you may want to selectively sell some stocks, but you don’t want to go to your brokerage and withdraw your portfolio. Instead, it’s time to analyze your performance and make informed decisions to adjust your holdings as market fluctuations bring out the best and worst of investment opportunities.
follow these steps to get started:
- Analyze performance since the recession. List on a spreadsheet the stocks you own in order of the percentage gain they’ve experienced since the market started falling. The stocks at the top of the list are the best performers during a bear market, but that doesn’t mean you should sell the stocks at the bottom of the list just yet.
- Analyze the overall performance of each farm. Consider the price you bought each share for compared to its current value. You may find that some stocks in your portfolio performed so well in the bull market that they are worth holding onto when the bears come out to play. In other cases, you may have held a stock for a few years and all of your gains have been wiped out in the first few months of a bear market.
- sell the rags. Now, it’s time to sell strategically. Start by selling losing stocks. add up the losses as you do. then look at the underperformers that are still in the green. You want to sell some of these, but you want to limit the profits you make to the exact amount of your losses. this process is called tax loss collection (more on this later). This strategy uses losses on some investments to offset capital gains taxes you would normally pay on gains on others.
- reallocate unused funds. Keeping in mind your investment strategy, reallocate the money you freed up through sales. buy more shares of your best employees. Also, consider buying shares of stocks that are going down but performed so well in bull markets that they were worth holding; That’s where you find the best discounts.
3. think long term
market corrections and crashes are nothing new. they happen so regularly that some experienced long-term investors don’t even pay attention to their short-term effects. there are good days and bad days no matter what long-term investment you make. when you make rash decisions about short-term trends, you often make mistakes.
There are some things that are hard to remember when markets are falling, but they will put your mind at ease:
- Market crashes are commonplace. market crashes occur every six years on average. every time they happen, the market goes into a chicken panic worthy of “the sky is falling”. Well folks, the sky hasn’t fallen yet.
- Market declines are short-term. the average market decline lasts about 342 days. That sounds like a long time, but it’s a drop in the bucket in the grand scheme of things. If each dip was exactly six years apart and lasted 342 days, there would be about 1,849 days of bull market activity between each dip. however, it is important to note that these are averages; the 2020 market crash only lasted about a month.
- what goes down must go up. There has been a significant rally in stock prices after every market crash in history. therefore, market downturns have historically presented opportunities to load up on the best at discounted prices and ride the wave back to the top.
4. rebalance your portfolio
When you created your investment portfolio, you kept a healthy balance in mind. You carefully considered your risk tolerance and chose your asset allocation to match. Some assets grow faster than others, and in a market downturn, some fall faster than others.
chances are your portfolio isn’t as balanced after a crash as it was when you first started investing.
As you rebalance your portfolio, reassess your risk tolerance. given the current market condition, you probably won’t feel as aggressive as you used to. If you’re not sure where you stand in terms of risk tolerance or comfortable with asset allocation, you can use your age as a guide.
For example, if you are 35 years old, consider investing 35% of your portfolio assets in fixed income securities, leaving 65% of your assets in stocks. Of course, this is just a rule of thumb based on moderate risk tolerance. If you want a more conservative portfolio while the storm passes, consider adding more bond allocation. If you prefer to take an aggressive approach while weathering the storm, consider a larger stock allocation.
5. consider tax loss harvesting
Tax loss harvesting is a strategy you can use to reduce the overall tax burden on your investments. You only pay taxes on the net earnings of your investments. that means you can use your losses to offset your gains, and a market crash is a good time to do so.
If you’ve made a profit at some point this year, consider selling some of your assets that are currently experiencing losses to offset those gains. note that losses offset gains on a one-to-one basis. If you have made $500 in the market, you will need to take $500 in losses to offset the tax burden on your gains.
It’s also important not to sell a stock just because it’s making a loss. For example, if you bought a stock three months ago and the market crashed a month ago, that stock didn’t have much time to grow to profitability before the dips. however, it may be falling more slowly than other assets in your portfolio, so it’s worth holding on to.
Instead of blindly selling stocks for tax purposes, strategically look for opportunities to use poor long-term performance as a means of reducing your tax burden.
6. take advantage of smart investment opportunities
Smart money investors, including big money investors like George Soros and Warren Buffett, see market corrections and declines as investment opportunities. In 1996, Buffett said, “Be fearful when others are greedy, and greedy when others are fearful.”
Although that quote is over two decades old, it is still true today. If accidents are opportunities for Wall Street bigwigs, they’re also opportunities for you.
buy the dip
warren buffett has a history of buying billions of shares of company stock during a market downturn. it is also a profitable move. is betting on entering at lower prices as fear grips wall street.
buffett knows that a bull market will soon follow any significant move lower. If he carefully researches each investment, looking specifically for quality stocks that the market has undervalued, he, too, can rely on the bull market bounce.
buy index funds
If you don’t feel comfortable buying individual stocks during a market decline, you can buy the market decline as a whole. Although some stocks may never recover, the market as a whole is known for recovering.
The best options for exposure to the entire market are broad-exposure exchange-traded funds (ETFs) and mutual funds, also known as index funds. These funds are created with diversification in mind and offer an inexpensive way to invest in groups of hundreds or even thousands of stocks at one time.
pay attention to merges & acquisitions
When the market is down and investors are scared, larger companies can acquire promising companies at deep discounts. Furthermore, companies that are willing to pay hundreds of millions or even billions of dollars to acquire another during a market downturn show financial strength.
At the same time, these companies are often undervalued thanks to a panicky market that doesn’t include the value of acquisitions in its valuation analysis. when the recovery happens, these companies come out of the crisis stronger than ever.
use dollar cost averaging
There is no way to accurately time the market. you don’t want to wait for a bounce and miss out on the best days, and you don’t want to buy too high and miss out on your chance to profit.
dollar cost averaging is the solution. By spreading your investments over time and making regular, even purchases of a stock, you can be sure you’re not buying at the top or missing the bounce.
7. prepare for the next stock market crash
This is not the first market sell-off and it won’t be the last. you don’t have to be caught off guard next time. there are a few ways you can prepare.
diversify your portfolio
No matter how aggressive the market is, you should protect the value of your investment portfolio with diversification. If you have a healthy mix of domestic and international stocks, your international plays will help offset losses in the event of a localized economic downturn. If you have a healthy mix of cyclical and non-cyclical stocks, your non-cyclical positions will ease the blow in the event of a local or global market downturn.
You can also take diversification one step further.
Consider investing in assets like real estate, precious metals, or even art. The stock market isn’t the only place you can find investment opportunities.
keep your balance
You shouldn’t wait for a stock market crash to rebalance your portfolio. If you have a passive portfolio made up of ETFs, you should rebalance your portfolio at least once or twice a year, but there’s no shame in doing it quarterly or monthly.
If you have an active portfolio consisting of individual stocks and fixed income securities, you should rebalance your portfolio much more frequently. quarterly rebalancing is a must, but you may have more success doing it monthly.
No matter how you invest your money, if you keep your balance at all times, you will go into crisis knowing that your portfolio will protect you against significant drops from which you will not be able to recover.
Stock market crashes are only part of the game. the market is dictated by fear and greed. In almost all areas of life, reactions are exacerbated when emotions are involved. the market is no different.
Market crashes are nothing to fear. Sure, they’re no fun when you’re in the teeth of a 30% drop in glory, but they do present opportunities that no other part of the market cycle offers.
think about it; You’d love to go to your favorite store and see a sign that says “everything 30% off.” To the savvy investor, a market crash is essentially the same on a grand scale.
The key to all of this is research and making wisely informed investment decisions. if you can do that, you can be sure that you will be fine.