5 Tips On What To Do When The Stock Market Crashes
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Over two decades ago, I felt like my life was in place. The real estate business was doing well and I owned a lot of stocks. I was earning well and it felt like all was under control. Then, when the 2008 stock market crash happened, it all seemed to fall apart. When the stock dropped, I panicked and sold several stocks, some of which I should have saved.
The truth is that stock market crashes can be a big problem. Sometimes, it can feel unexpected and scare you into making hasty decisions. It happened to me, and it might happen to you. So, if you want to know what to do when the stock market crashes, here are five tips to help you out!
What exactly is a stock market crash?
First of all, let’s understand what a stock market crash is. As the name implies, it’s a sudden and hefty drop in stock prices. Usually, the figures would have to fall in double-digit percentages. For instance, the 2008 financial crisis led to a 57% loss for the S&P and took 17 months before the economy recovered. Other examples of a stock market crash in the past include:
- The Great Depression: Around the end of the Roaring 20s, the price of stocks began to fall around September. What shocked many people, however, was when it dropped by 13% on October 28, then another 12% on October 29. Now known as Black Monday and Black Tuesday, the sudden percentage falls caused a wave of panic selling amongst investors. Eventually, by 1932, the market would hit its lowest ever percentage at 89% below peak. It would take another 22 years before it regained its previous values.
- Black Monday: October has had a memorable history in the financial world. On October 19, 1987, the Dow Jones Industrial Average, one of the most recognized stock market indexes in the world, dropped by 22.6%. The result? Over $500 billion in losses and a highly volatile market. It took years for the economy to recover, during which they introduced new policies to avoid another drop. Such policies included new trade-clearing protocols and circuit breakers that could temporarily stop trading, should a large decline in percentages happen.
- The COVID Crash: The most recent example of a stock market crash was caused by the pandemic of COVID-19. Due to the restraints caused by the virus, from quarantines to social distancing, most businesses had to act quickly. Many of them either shut down or suspended their operations. The result was a 34% drop in the stock market. However, the US government responded quickly by injecting trillions of dollars into the market and providing stimulus payments. With this, the stock market regained its peak in just over 30 days.
How did this happen?
While stock market crashes have happened in the past, the reasons that they occur can vary. In some cases, mass hysteria and panic buying could lead to financial disaster. In other cases, unexpected disasters or health crises have caused the market serious damage. Here are four reasons why a stock market crash could happen.
Reason #1: The financial cycle is changing.
The first reason why a stock market crash happens is the financial cycle’s changes. Like the seasons of the year, economies go through boom periods and bust periods. Sometimes, the rates of unemployment are relatively low while the profits of different companies go sky-high. During these periods, you enter what is known as a “bull market”.
The exact opposite is known as a “bear market”. When inflation happens and causes prices to rise up, then it gets harder to afford anything. All the things you’re used to, from rent to utilities, start to cost more. While a bear market doesn’t necessarily lead to a crash, it can cause panic buying and spending. Speaking of which…
Reason #2: Investors panic and cause a chain reaction.
One of the most common reasons that crashes occur is panic. Stockholders can sometimes see a drop in percentage and get frightened. They worry that their investments will be worth much less within a few days. Not wanting to lose their money or their value, they quickly sell their shares to stay protected. Soon, more sales happen and stockholders follow the trend, causing panic to erupt as they find themselves headed to a crash.
Sometimes, the panic caused by investors isn’t based on a drop in prices or value. Sometimes, they fall for a lucrative option or investment. In their minds, these options can become profitable shares in the future. Then, once it starts performing, it disappoints, sometimes badly. The resulting sell-off to protect their money then causes panic in both investors and companies, especially those hoping for the best.
Reason #3: A disaster, either natural or man-made, has hit the country.
As mentioned before in the 2020 COVID Crash, natural and man-made disasters can harm the stock market. Depending on how serious the damage is, businesses can stop and stock values could fall. As demonstrated during the pandemic, a lot of industries can be affected by disaster. In some cases, the consumers could also start panic-buying for the disaster, like storing canned foods to prepare for a tornado or flood.
Reason #4: An economic crisis has occurred.
Sometimes, the reason a crash occurs comes from an economic crisis. In this case, it’s not necessarily the stock market that could be the cause. There have been many instances throughout history where other industries, from oil to real estate, have faced financial problems.
For example, the subprime mortgage crisis of 2007-2008 led to the eventual collapse of the stock market. Earlier in the decade, mortgages to high-risk borrowers increased due to deregulation in the banking industry. However, these borrowers could not meet their payments, which slowly caused house prices to drop. Once the housing market fell, the mortgages were sold off to institutional investors. Unfortunately, they also ended up suffering losses, including the aftermentioned 777.68 drop in the stocks.
What should I do when the stock market crashes?
Whether you like it or not, the truth is that stock market crashes are inevitable. Just as the financial cycle goes up and down, stock market crashes will happen at some point. That said, there are many safeguards the government has taken to minimize the problems and damages it causes. For example, the stock market fell by 34% during the pandemic and managed to bounce back within a month’s time.
That said, it’s always a good idea to prepare if it does happen. If you’re wondering what to do when the stock market crashes, here are five tips you can use to stay safe.
1. Settle your debts.
If you have any outstanding debts to cover, such as student loans and mortgage payments, you should pay them off ASAP. Going into debt is never an ideal scenario. However, if you’re in debt while the stock market crashes, you’re more likely to panic sell your shares to make even. Doing so could lead to you missing out on a better deal when the market does rebalance itself.
If you can pay off your debts with the money you have now, do it as fast as you can. If your cash flow is not enough, look for ways to pay it off immediately. Otherwise, the rates of interest will likely rise during a crash. If that happens while you’re in debt, you’ll be forced to pay higher fees and lose more money in the long run.
2. Make a backup budget.
If you fall out of a plane, what’s the one thing you’d want with you? Ideally, it would be a parachute to help you stay safe. That’s the kind of help a backup budget can give you. Also known as an “emergency fund”, it can cushion your financial problems during a stock market crash. With a backup budget, you have more time to recover and consider what to do when the stock market crashes.
While many people say that a backup budget should be worth three months of expenses, I’d double that. I think six months’ worth of budget is much more effective. One reason why is that people often lose their jobs during a stock market crash. If you get laid off, you’d want a good amount of cash to keep your needs met. That way, you can focus on finding new opportunities to earn money again without the stress of your bills and expenses.
3. Withdraw money from your investments.
In many cases, investors tend to panic sell their stocks during a crash. In their minds, it’s the best way to protect their finances. However, doing anything in a panic, especially with your money, is never a good idea. While you can sell your stocks, you shouldn’t rush to get rid of them for the sake of a profit.
The first rule on what to do when the stock market crashes is to know what you’re working with. Assess the investments that you have and see how much they can give you. For example, bonds are a good source of money when you need them most. Because they can be converted into cash, you can withdraw more of them when you need to sustain yourself.
4. Know the value of your stocks.
As with any investment, you need to know how much your stocks are worth. In the event of a crash, the ones that have a solid business model and longstanding value will succeed. Conversely, short trends and fads may cost a lot for a couple of months, but will definitely lose value over time. In short, to know what to do when the stock market crashes, you should research the stocks you want to own or are buying.
There are many ways you can start the research process. You can look up hundreds of articles and financial columns about the value of different stocks and their trajectory. You can analyze their business model and their performance over the years. You can even use a stock market simulator to forecast their worth. Once you decide on which stocks to buy, get them when the prices are lower. That way, you can sell them when the time is right and gain some leverage to survive a stock market crash.
Once you decide on which stocks to buy, get them when the prices are lower. That way, you can sell them when the time is right and gain some leverage to survive a stock market crash.
5. Stay calm.
Above all else, do not panic. Nothing ever good happens when someone panics during a crisis. Many investors have lost lots of money because they sold much of their stocks out of fear and worry. Not only does that lead to a stock market crash, but it could also ruin their finances in the future.
Don’t make the same mistake. When you want to know what to do when a stock market crash happens, start by calming yourself down. Once you feel ready, assess your stocks and see what you can do to get through it.
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- Ali, M. (2022, May 16). 5 Tips On What to Do When the Stock Market Crashes. YouTube.
- Federal Reserve History Authors. Accessed on February 1, 2023. Stock Market Crash of 1987. Federal Reserve History.
- Kavanagh, R. (2022, July 27). What is a stock market crash? Understanding the causes and consequences can help investors prepare. Business Insider.
- Vaughn, H. (2022, September 23). The Five Biggest Market Crashes in U.S. History — and How to Prepare for the Next One. NextAdvisor With TIME.
- Williams, W. (2022, September 23). Timeline of U.S. Stock Market Crashes. Investopedia.
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