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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.
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:
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.
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…
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.
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.
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.
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.
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.
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.
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.
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.
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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