A market crash can be psychologically devastating. It’s tempting to watch the market obsessively, reading the news headlines, sweating, watching your hard-earned money decrease in value each day, every day. The fear that things will continue to spiral downward out of control and wipe out your savings is real. But what should you do? Every market crash is different, but they end the same. An eventual recovery over time. If you are properly diversified and have a long time horizon, here is what you should do during a market crash.
1) Don’t Panic
This is easier said than done but the advice still holds. Take a deep breath, remind yourself that the market has always come back, and distract yourself from reading the news headlines. Other tips include removing or hiding the stock market app on your phone. You’re investing for the long-term remember (or should be). It doesn’t matter what the stock market does in the next 5 minutes, let alone the next 5 days, 5 months, or 5 years. Warren Buffett has no idea what the market will do in the short-term and neither should you try.
2) Learn from History
Think of all the major events that have occurred in the 20th century.
- First World War
- Great Depression
- Spanish Flu that killed over 100 million people
- Second World War
- Multiple recessions
- Korean War
- Vietnam War
- Cold War
- Gulf Wars
- 1990 Tech Bubble
- 9/11 Terrorist Attacks
- Asian Tsunami
- Great Recession of 2008-2009
If you invested $500 in an S&P 500 index fund in 1901 and held on until today, your investment would be worth over $7 million. Think about that for a second. Granted your investment time horizon is unlikely to be over one hundred years long but the argument remains the same. Investing for the long run will result in exponentially larger gains by the time you reach an age you would like to retire at. And the market recovered after every single one of these huge and at the time, seemingly world-ending events. If you were alive during any of them you may recall the news was flooding with negative headlines daily and people were panic selling.
Flash forward to today and at the time of this writing, the biggest scare is the coronavirus. Do you think the coronavirus outbreak will be as big as the Spanish Flu that killed more people than World War I? And even if it will be the market will recover eventually.
3) Automate Your Investing
By watching the stock market incessantly you’re catering to the amygdala part of your brain or where our feelings of fear, greed, and impulsivity come from (all enemies of a smart investor). If the market drops and you feel fear, this is your amygdala talking. The best way to work around your amygdala, and prevent it from hi-jacking your investing decisions, is by automating your decision-making process hereby taking all emotions right out of it.
Start by setting up regular account transfers between your checking account and investment account after every paycheck. One of the first rules of personal finance is “paying yourself first.” That is, setting money aside to save and invest before you even get a chance to look at it.
The second part is figuring out what to invest in. I recommend investing in a stock market index, like the S&P 500, that tracks the largest, well-known U.S. based businesses representing a wide range of industries. For more, see my article “Why a Single Investment Can Be All You Need to Retire.”
The best part of automating your investing is you will be buying when the stock market is high and when it is low, averaging out your investments over time. This is called dollar-cost averaging, and it’s what allows you to take the stress and human element out of making an investment decision beating your amygdala once and for all.
4) Don’t Believe the Experts
So-called experts have been wrong far more often than they have been right. In fact, on the off chance they are right, it’s by luck. To prove this the International Money Fund in 2018 conducted a study analyzing 153 recessions across 63 countries from 1992 to 2014. The researchers found that economists only predicted 5 of the 153 recessions by April of the preceding year. Even in rare cases when they accurately predicted a looming recession, they usually underestimated its extent.
Financial advisors, equity research analysts, economists, talking heads on the news, they are all the same. If you see one on TV, do yourself a favor and change the channel.
“Forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.” —Warren Buffett
5) Don’t Time the Market
It’s human instinct to try and time the market. Whether it’s to buy or to sell, we are wondering if we made the right decision. Guessing is not an investment strategy. It’s a waste of time, and more importantly, will harm your investment returns.
One of the biggest fund managers, Blackrock, conducted a study on how most investors behaved between 1997 and 2016. The average return for the stock market during this period was 7.68% per year. The average return for the average investor during the same period? 2.29% per year. This is because the average investor was actively investing their portfolio, buying and selling, trying to time the market, thinking they could outsmart everyone else. Guess what? They didn’t.
Not only do you need to know when to sell, you might also be thinking when to buy back in and while it’s nearly impossible to be right the first time, it is impossible to be right on both. And, assuming you are well-diversified, are investing for the long term, and don’t need the cash (if you did need the cash you should not be investing it), it’s far better to ride out the crash and if you can, buy more when the market drops.
6) Buy More if You Can
As previously mentioned, I recommend automating your investing. But if you have some spare cash, and were planning on investing it eventually anyway, consider investing during a crash. You can’t time the bottom but you can buy when the stock market is on sale. Warren Buffett once said, “Buy when there’s blood in the streets.” During the 2008-2009 Financial Crisis, he did exactly that. Since then the market has gone up over 300%. Not too bad over ten years.
7) Avoid Using Leverage
Investing using leverage is borrowing money and then investing it. Real estate investors swear by this saying why use your own money when you can use other people’s money to make a dollar. While this may be true when the real estate market or stock market is rising, it is even more painful if and when the market drops. For example, let’s say you borrowed $10,000 and invested it in the stock market and the market subsequently drops 20%. Not only are you down $2,000 on your investment, you still owe the bank $10,000, increasing the money you owe to $12,000. Furthermore, your investment now has to rise 25% to get back to even. Meanwhile, you are paying interest on the borrowed funds eating into your losses even more.
It may be tempting to borrow money to buy stocks when there’s a crash, but it could crash further, and the stock market has a tendency to be irrational longer than you can remain solvent.
“It’s crazy to borrow money to buy stocks.” – Warren Buffett
Legal Disclaimer: The views expressed by Mr. Dumont on Money Sensei are solely his and not intended as investment advice nor a guarantee of any financial return. Mr. Dumont is not an investment or tax professional, so the information contained on the blog is not a substitute for professional advice. The contents of this blog are accurate to the best of his knowledge at the time of posting, but rules and laws are ever-changing. Please do your research to confirm that you have the current information.