Stock market crashes are a normal part of investing, but when the market plummets 48% in less than two months, as it did in 1929 — or almost 23% in a single day, as in 1987, or 54% as happened during the 2008-09 financial crisis — it’s hard not to panic.
But you shouldn’t let fear guide your decisions in a crash, because you’re all too likely to make a big investing mistake: buying high and selling low. Let’s go over the basics of stock market crashes, and what you can do about them.
How can I prepare for a market crash?
The best time to deal with a crash is before it happens. (That said, if you’re reading this as one is happening, we’ve got you covered in the next section below.) Here’s a list of top things to do:
- Check your risk tolerance. If market turbulence makes your heart palpitate, you might have too much money invested in stocks. Take a moment to consider whether it makes sense to switch to a more conservative portfolio that includes bonds, for example. If you’ve got a long time until you need the money, stock-market returns are a powerful way to grow your account. Learn more about how diversification can reduce your investment risk.
- Evaluate your investing goals. If you’re investing for a long-term goal like retirement, then letting your money ride the market’s ups and downs can make sense, especially if you’re feeling good about how you’re invested. But if you’re going to need this money in less than five years, then it’s time to consider whether that money should be in a less-volatile investment.
- Prepare to buy. Smart investors know that a market crash means stocks are effectively on sale. It’s a good time to buy, so it might make sense to have cash available to do just that. Just make sure any stocks you do pick up during this time fit in your broader investment strategy.
- Consider getting help. If the market’s gyrations are making you second-guess investing altogether, it might be time to call in the experts. There are robo-advisors — online digital advisors that manage investment portfolios — as well as human advisors.
» Read more: Will the market crash? Yes. Here’s what to do.
What is a stock market crash?
A stock market crash occurs when stock prices decline sharply in value over a relatively short period of time. There are different names for various types of market downturns. For example, a dip tends to be a mild drop, say, 2%. It might briefly interrupt a long stock-market climb. A correction, on the other hand, by definition will push the market down by 10% or more.
The word “crash” is somewhat open to interpretation. Most one-day declines don’t fit the bill because volatility — the tendency for stock prices to go up and down — is an inherent dynamic in the stock market. Generally speaking, the word “crash” starts getting bandied about when declines are severe or persistent, and when they affect a majority of stocks.
» Read about the difference between market crashes and corrections.
Why does the market crash?
The market crashes when more people want to sell stocks than buy stocks. Why does that happen? There are as many answers to that question as minutes in a 24/7 news cycle. The market can be affected by negative economic reports, especially if that news is unexpected (like signs the pace of U.S. economic growth is slowing or stalling), as well as bigger-picture catastrophes (such as a terrorist attack).
Market sell-offs can be made worse by the fact that investors hear the news of a market drop and decide they need to sell, too.
But sometimes it’s not entirely clear why a market moves one way or the other. And market sell-offs can be made worse by the fact that investors hear the news of a market drop and decide they need to sell, too.
How does a crash affect me?
The most direct way a crash can affect you is a loss of value in your investment portfolio. During market crashes, the media generally focus on what’s happening to the Standard & Poor’s 500, an index comprising the largest U.S. companies, and the Dow Jones Industrial Average, a smaller set of some marquee companies. Your investment portfolio is likely composed of different assets that don’t necessarily follow these indexes. As long as you’ve got some bonds or cash providing a ballast against the stock turbulence, your own investments won’t be as bad off as the S&P 500 on its own.
That said, it can be tough to see any loss of value when you peek at your investment account. Three tips:
- Don’t obsess over your account statement. Try to ignore the headlines and your account balance, and focus on why you’re investing and how beautifully diversified you are.
- Put market moves in perspective. The S&P 500 dropped 5% to 10% six times from 2011 to the beginning of 2018. We’re all still here.
- Remember that people who owned a diversified portfolio and held on to those investments through the worst part of the financial crisis ended up recovering those losses and posting significant gains within a few years. The S&P 500 has enjoyed an average annual return of about 8.6% from 2008 through 2017 (adjusted for inflation and assuming dividends are reinvested).
A crash is happening — what should I do now?
The first rule is to stay calm. If you’re investing for a long-term goal, your first task is to remember that market declines are a normal part of investing. You’re not required to make changes or adjustments. You can simply sit out the storm, change the channel, go outside for a run — do anything but panic.
This is not the time to sell investments. To do so is to make that age-old investor mistake: selling low. Instead, think about buying stocks that are now, suddenly, less expensive. Here’s what to do during a market crash.
When is the next stock market crash?
There are plenty of market prognosticators who claim to have the answer to this question, but market downturns are impossible to predict. Smart investors accept that investing in the market comes with ups and downs. Instead of wondering when it’s going to happen, focus on how to prepare for the next one.