What To Do During a Stock Market Crash
Whenever the stock market reaches new highs, the doomsayers start coming out of the woodwork. “A crash is coming,” they lament. “The market’s going to crash!” But what exactly is a stock market crash? And more importantly, how can you protect your investments in the event of one? Here’s what you need to know.
See: 5 Things You Must Do When Your Savings Reach $50,000
What Is A Stock Market Crash?
A “stock market crash” is a sharp decline in one or more of the major market indexes in the U.S., which are the Dow Jones Industrial Average, the S&P 500 and Nasdaq. There’s no specific percentage drop associated with a crash, unlike a correction, which is a drop of 10% or more from the index’s 52-week high. In the past 45 years, there have been 24 market corrections.
What Are Some of the Causes of Stock Market Crashes?
A market crash can be caused by a number of factors. Past experiences include 1929 when the market collapsed and investors couldn’t meet margin calls. Another example was the tech crash in 2000 when the price of tech companies rose very quickly, the subsequently plummeted. Here are some of the biggest market crashes in the U.S, and what caused them:
The Great Crash of 1929
The Great Crash of 1929 is what most people think of when they think of a stock market crash. The Roaring ’20s, a time of historic prosperity, came to a grinding halt with the market crash of 1929. Stocks had been so actively traded, mostly on margin, that the market simply collapsed, and investors couldn’t pay their margin calls. During this crash, the market fell 12.8% in a single day.
The Stock Market Crash of 1987
The crash of 1987 was caused by a rash of mergers and acquisitions, particularly in the nascent technology sector. This crash saw the market drop 23%.
The Tech Wreck of 2000
The tech wreck of 2000, sometimes referred to as the dot-com bubble, was more of a long, slow drop than a crash. In this crash, a spate of initial public offerings drove prices up wildly, and what goes up must come down. Many companies that went public in IPOs during this time went bankrupt shortly afterward.
The Great Recession of 2008
The Great Recession of 2008 was a crash that was caused by the decline of mortgage-backed securities, which had become a popular investment touted by Wall Street banks. Banks were writing mortgages with no or low down payments, and homeowners began to have trouble keeping up with their payments. As they defaulted, the securities that were invested in these mortgages fell, and the market crashed.
COVID-19 and the Crash of 2020
The coronavirus crash of 2020 was caused by the global pandemic that swept the world in the early months of that year. The Dow Jones Industrial Average dropped 37% between Feb. 12 and March 23 as businesses closed and unemployment soared. The government quickly stepped in to help, however, and by the end of 2020, the DJIA was actually up 6.6% for the year.
The Inflation/Rising-Rate Cycle of 2022
After relatively big years for the S&P 500 in 2020 and 2021 — when the market ultimately returned 16.11% and 26.89% in those years, respectively — some profit-taking was likely to begin in 2022. However, this potentially mild drawback was pushed into overdrive by the highest inflation rates in 40 years, topping 9% in June. As a result, the Federal Reserve kicked into overdrive, enacting the most aggressive rate-hiking campaign in its history, including four unprecedented 0.75% raises in 2022 alone. As a result, the S&P 500 fell over 20%, while Nasdaq cratered by more than 37%.
The best advice on what to do in the event of a stock market crash comes from legendary investor Warren Buffett, who said, “Be fearful when others are greedy, and be greedy when others are fearful.” Don’t panic and sell when there’s a crash. Hang on, and, if you can, buy the dip. Prices drop when everyone is selling, so take advantage. Just make sure your portfolio is balanced.
What Happens After a Stock Market Crash?
There is always a lot of hand-wringing when the stock market crashes, but it’s important to keep in mind that after every crash so far, the market has always eventually gone up. This has never been more evident than in the coronavirus crash of 2020. On March 16, 2020, the DJIA closed at 20,188, having fallen from 29,551.42 on Feb. 12, 2020. On July 26, 2021, the Dow closed at 35,144.31.
Protecting Your Investments in a Crash
Just like you wear a seat belt to protect yourself in a car crash, there are steps you can take to protect your investments in the case of a market crash. Here’s a three-step plan:
Make sure your investments are diversified. Some crashes are led by a single sector, like the tech wreck of 2000. Investors who had all their money in shiny new technology stocks took a far bigger hit than those who had at least some money in more traditional companies. Your portfolio should reflect different sectors, industries, geographies and company sizes.
Rebalance your portfolio regularly. When a certain sector is on fire, it’s tempting to ride the wave. But if you don’t rebalance regularly, you could find yourself with an outsized allocation in a vulnerable sector. Review your investments at least quarterly to make sure you’re diversified the way you want to be.
Don’t panic. This bears repeating — if the market crashes, avoid the temptation to jump on the bandwagon and sell. Staying the course is often the most prudent strategy.
Investing is risky, but it’s also rewarding. Understanding the risks and having a plan to deal with them can help you live with the risks so you can enjoy the rewards.
John Csiszar contributed to the reporting for this article.
This article originally appeared on GOBankingRates.com: What To Do During a Stock Market Crash
