I remember my first time like it was yesterday.
And when I say “my first time,” I’m obviously talking about the first time I watched the value of my investment portfolio plummet in a stock market crash.
Between February 19, 2020, and March 23, 2020, the S&P 500 dropped 34%.
Covid-19 had reared its head. Businesses closed, nations went into lockdown and the stock market crashed on the realization that the situation was a lot more serious than previously imagined.
Part of me wanted to sell everything. To cut my losses and stop the bleeding.
This is what a lot of people do when they’re faced with the reality of a stock market crash.
And it’s precisely the reason why they end up losing their money.
History repeating itself
We have had three major stock market crashes in the last twenty-five years.
- The dot-com bubble
- The 2007–2008 financial crisis
- The Covid-19 stock market crash
Look at the performance of the S&P 500 during that time. The blue circles indicate the point at which the market reached its bottom following the events mentioned above.
After each one, the market has gone on to recover and reach a new all-time high in the years that followed.
There is no reason to think that the pattern won’t repeat the next time around.
It’s simply a matter of time.
Between the market bottom on March 23, 2020, and August 16, 2021, the S&P 500 doubled in value.
Anyone who sold during the month or so of market decline at the beginning of 2020 would have missed out on the spectacular gains during the market’s recovery.
Did anyone expect the market to begin its recovery so quickly? Probably not.
Nobody knows how long it will take the market to recover, but we can be sure that it will recover.
Before you invest a penny, ask yourself the following question:
When will I need the money that I’m investing?
Your answer determines your best course of action in the event of a stock market crash.
Long Term (10 years+)
The longer you plan on investing, the more risk you can afford to take. In a stock market crash, more often than not the best thing long-term investors can do is absolutely nothing.
Yes, a stock market crash would cause a substantial drop in the value of your investments in the short term, but your longer-time horizon will almost certainly allow you to recover from any losses.
Consider:
- Mutual funds offering a high percentage allocation to shares
- Buying individual stocks (always do your own research)
- Options trading
Continue to add to your investments if you’re able, this will help to maximise your gains during any subsequent recovery.
Intermediate-Term (5–10 years)
The closer you are to needing your investments, the less risk you should be taking. Those with a timeframe of five to ten years should consider more conservative investments:
Consider:
- Mutual funds offering a mixed allocation to both stocks and bonds.
- Index funds as opposed to individual stocks
- Keeping a portion of your investments in cash or cash-equivalent investments (more information below)
Maintaining exposure to stocks will help to grow the value of your investment, but bonds will provide an element of stability to your portfolio, alongside the added bonus of fixed-income payments.
Holding cash or cash equivalents will further lessen your risk, but this comes at the expense of providing much lower returns.
Short Term (within 1–5 years)
Investing in stocks for the short term is generally considered to be a risky strategy. If a drop in the market occurs, there may not be enough time for the market to recover before you need the money.
Consider:
- High-yield cash savings accounts
- Short term corporate or government bonds
- Certificates of deposit
Any of these options lessen your degree of risk while providing easy access to your money when you need it.
The bottom line
The stock market is a guaranteed way to build your wealth over time. But with that guarantee comes another, that you will experience periods of market volatility and downturn.
Trying to time the market is a fool’s game. Your time in the market is what matters in the long run.
- Understand that the market will drop.
- Know your time horizon and invest accordingly.
- Rebalance your investments as your time horizon changes.
