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One minute, the market's hitting record highs. The next — blammo — it can be in the throes of a stock market crash.
Is the stock market crashing?
Stock market crashes are only clearly identifiable in hindsight, but many investors have worried about a crash in 2022. Throughout the year, the markets have been experiencing extreme volatility over concerns about rising inflation, interest rates and global geopolitical uncertainty.
While investors found some relief mid-summer, by the end of August, worries of a sustained downturn resumed, as the S&P 500 and Dow both fell more than 4%.
By December, the S&P 500 was down more than 15% for the year, and the Dow was down more than 6%.
Although history can tell us how long crashes, stock market corrections and bear markets typically last, no one gets a calendar notice announcing the time, nature and projected magnitude of future dips.
What is a stock market crash?
While there’s no specific number that indicates a crash, here’s a bit of context. The S&P 500 stock index typically changes between -1% and 1% on any given day. Anything outside these parameters could be considered an active day on the stock market — for better or for worse.
If the S&P 500 drops 7% in a single day, trading may be halted for 15 minutes. This has only happened a handful of times in the market’s history, and indeed marks a very bad day on Wall Street. A crash is marked by a sharp and sudden drop in stock prices, usually following an uptrend in the stock market, also known as a bull market.
Stock market crashes in history
Even though the stock market has its roller-coaster moments, the reality is that stock market crashes aren’t that common. A few of the major U.S. stock market crashes of the past hundred years include:
1929: The stock market plunged in response to a contracting economy and investor panic, marking the onset of the Great Depression. The market bottomed out in 1932, more than 80% below peak prices, and took over two decades to recover.
1987: The market plunged 25% in response to market decline, investor panic and early computerized trading gone awry, on a day known as Black Monday. However, the market recovered within two years, and the Securities and Exchange Commission implemented trading curbs and circuit breakers to prevent panic selloffs.
2000: Following a surge of investing and speculation in internet-related ventures during the 1990s, the Dot-Com Bubble burst in March 2000. The S&P 500 dropped nearly 50% and took seven years to recover.
2008: In response to the housing bubble and subprime mortgage crisis, the S&P 500 lost nearly half its value and took two years to recover.
2020: As COVID-19 spread globally in February 2020, the market fell by over 30% in a little over a month. But by August 2020, the market had already rebounded, taking six months to recover.
Here’s a look at what the S&P 500 is doing today compared with the previous trading day.
Stock market data may be delayed up to 20 minutes, and is intended solely for informational purposes, not for trading purposes.
If you have a long investment timeline and are properly diversified, it’s often best to ride out the downturns. And understanding that a crash could happen means you can plan for it and react thoughtfully. Here's a five-step game plan for what to do when the market crashes.
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1. Know what you own — and why
A fear-driven reaction to a temporary slump isn't a good reason to dump an investment. But if you look back at your original stock research notes, you may find some good reasons to sell.
Thorough stock research includes a written record of the strengths, weaknesses and purpose of every investment in your portfolio, as well as things that would earn each investment a place in the "out" box. Your research is like an investing road map, a tangible reminder of the things that make a stock worth holding.
During a market downturn, this document can prevent you from tossing a perfectly good long-term investment from your portfolio just because it had a bad day. On the flip side, it also provides clear-headed reasons to part ways with a stock.
Ideally, before diving into stocks, you gauged your risk tolerance, or how much volatility you’re willing to stomach in exchange for higher potential returns. Investing in the stock market is inherently risky, but what makes for winning long-term returns is the ability to ride out the unpleasantness and remain invested for the eventual recovery, which, historically speaking, is always on the horizon.
If you skipped this step and are only now wondering how aligned your investments are to your temperament, that’s OK. Measuring your actual reactions during market agita will provide valuable data for the future. Just keep in mind that your answers may be biased based on the market’s most recent activity.
2. Trust in diversification
When a market decline hits, your results may vary — and perhaps for the better — if you’ve invested money across different baskets of asset classes like stocks and bonds. Diversifying, or distributing your money across investments, is key to reducing investment risk and smoothing the ride through a tumultuous market. Diversifying helps ensure your investments (eggs) aren’t concentrated in one type of asset (basket). So if one stock or industry has a bad day, your other investments may help offset those losses.
If you’ve gone with a “set it and forget it” strategy — like investing in a target-date retirement fund, as many 401(k) plans allow you to do, or using a robo-advisor — diversification already is built-in. In this case, it's best to sit tight and trust that your portfolio is ready to ride out the storm. You’ll still experience some painful short-term jolts, but this will help you avoid losses from which your portfolio can't recover.
» Seeking a safe investment option? Consider these low-risk ways to grow your money.
3. Be ready to buy the dip
Market dips can also be a buying opportunity. Think of it as buying stocks on sale when the market crashes. The trick is to be ready for the fall and willing to commit some cash to snap up investments whose prices are dropping.
Here's how to tell if you might be ready to buy the dip: You already have an emergency fund, you’ve allocated money for retirement and you have cash available for everyday expenses. You’ve set aside some cash so you’re ready for a flash sale when disaster strikes, and you keep a running wishlist of individual stocks you would like to own.
If you do buy the dip, you probably won’t catch the stock at its low, but that’s fine. The point of value investing is to be opportunistic on investments you think are worth more than their current market price and have good long-term potential.
Don’t be surprised if you freeze in place during the moment of opportunity. One strategy to overcome the fear of bad timing is to dollar-cost average your way into the investment. Dollar-cost averaging smooths out your purchase price over time and puts your money to work when other investors are huddled on the sidelines — or headed for the exits.
For long-term investors, a market downturn can simply mean stocks and other investments are on sale. If you're not already investing, you can take advantage with one of our picks for the best investment accounts.
4. Get a second opinion
Being an investor is rewarding when the stock market’s on a tear and your portfolio is going up in value. But when times get tough, self-doubt and ill-advised tactics can take root. Even the most confident saver-investor can fall victim to harmful short-term thinking. Don't let self-doubt sabotage your financial plans.
Consider hiring a financial advisor to kick the tires on your portfolio and provide an independent perspective on your financial plan. In fact, it’s not uncommon for financial planners to have their own financial planner on their personal payroll for the same reason. An added bonus is knowing there’s someone to call to talk you through the tough times.
» Looking for an advisor? We have a list of the best financial advisors.
5. Focus on the long term
When the stock market declines, it can be difficult to watch your portfolio’s value shrink and do nothing about it. It can be especially hard to watch your portfolio shrink in a year when you might have gotten sick, grieved, or lost or changed jobs due to the COVID-19 pandemic. It’s normal to feel pessimistic after a crash, but if you’re investing for the long term, doing nothing is often the best course.
It's important to remember that when you sell investments in a downturn, you lock in your losses. Take the February 2020 COVID-related market crash. Say, you'd had $1,000 invested in an exchange-traded fund, or ETF, that tracked the S&P 500. Such a fund would have lost more than 30% of its value during the spring 2020 crash. If you'd had sold, you would have locked in that 30% loss, but if you'd held onto it, you would have recovered your losses by that August.
If you plan to reenter the market at a sunnier time, you’ll almost certainly pay more for the privilege and sacrifice part (if not all) of the gains from the rebound.
6. Take advantage where you can
Watching your carefully curated portfolio take some unpleasant dips can be painful. But making moves for future-you could help offset some of that discomfort. Financial planners often point out that market declines can be good timing for Roth conversions. Investors can take stock of the depreciated assets in their traditional IRA and transfer some of that money into a Roth IRA. Once the market begins to recover, you can happily watch those migrated assets grow tax-free.
It's important to note that Roth conversions may not make sense for everyone, though. One concern is that they often trigger additional taxes since the transfer creates ordinary income. Talking with a tax professional can help clarify if the move makes sense for you.
» Ready to dive deeper? Roth IRA conversions and how they work.