I write a lot about the emotional side of trading and investing and the impact of big price changes (both profits and loss) so I wanted to publish this post by Marjolein from Radical Fire on stock market crashes. Tim
Many people ask themselves how to react to a stock market crash? Especially during periods like these, it is important to stick to your investment plan.
If the stock market crashes, people start to question themselves and their financial decisions.
They want to know why it is happening, when it will stop, and how much more losses they need to take.
No one knows these things for sure. Just keep in mind that the stock market is no angry beast that wants to swallow all your money.
The stock market is your friend. Just like anyone else, it has highs and lows. The highs will always come back, it may just take a while.
That’s why it is important to get over your fear of the stock market and start investing. When you experience the mindset shift of investing for the long-term and not looking at the temporary volatility, you’re winning.
There are a couple of important rules of thumb that I want to share with you:
- Invest money that you don’t need short-term
- Time in the market beats timing the market
How should you react when there’s a stock market crash? Should you sell your stocks? We’ll dive straight into it!
Invest Money You Don’t Need Short-Term
When you’re investing your money, that means you’re putting money away in the market today so that you have more money later.
If you expect to need money in the short term, you don’t invest it in the stock market but you start building your emergency fund.
Money that you don’t need in the short term you can invest.
HOWEVER, don’t dump everything in stocks and be done with it.
This is about how risk-averse you are. How much risk can you handle without selling your entire portfolio or getting sleepless nights when the market goes down?
If you have a low-risk tolerance, buy bonds. They are more stable but will grow slowly.
If you have a high-risk tolerance, buy stocks. They are very volatile and will grow faster. Be aware that it will be a bumpy ride with potential ups and downs along the way.
Your Age Plays A Role In This
When you’re young and you don’t need the money you’re investing any time soon, you can take a little more risk. Your working income will cover your costs, so that money can be used to cover your monthly bills.
This means that when you’re young, you can invest most of your money in stocks. You are not touching the stocks until 20+ years down the road. At that time, your stocks will be worth a whole lot more.
Temporary volatility is fine because you don’t rely on your investments to support you at that time.
When you’re getting older and no longer have a working income to cover your costs, you will depend on your investments and passive income in order to pay your bills.
This means that when you’re getting older, you could invest more of your money in bonds. Because you need the money in the short term, it is better to have a less volatile investment.
If there’s a stock market crash and you are forced to sell your stocks for half the price, you will not be happy. But if you invest the majority of your money in bonds, this volatility will be much lower and your investments more constant.
This is great when you need to extract money monthly to pay the bills.
Time In The Market Beats Timing The Market
The fact that a market correction will occur is certain. The thing is, no one knows when it will happen or how much the correction will be.
Time in the market beats timing the market!
Trying to time the market is such outdated financial advice.
If you missed the best 10 days of the stock market between 2004 and 2019, your return will be an average of 4.11% instead of an average of 9%.
Why? Because no one can predict when the good days are going to come. When you are missing out on those, your return can be highly impacted.
Unfortunately, we can’t predict the future so we don’t know when we should get in or out of the market. The simplest way to get the maximum return is to ride the entire wave. Up and down.
If there is one thing that we’ve learned from Warren Buffett, it’s that to be patient and go against the herd.
‘Be fearful when others are greedy and be greedy when others are fearful’ – Warren Buffett.
Look at the long-term and don’t sweat it when the market is temporarily going down. This could be the chance to buy new stocks and to get to that upward wave again.
How To React To Stock Market Crash?
Over the last week, this has been the movement of the market. I’m currently looking at VRWL, which is a world economy index fund invested in over 3000 companies.
The stock market regularly drops 10%+ at a time, for example below:
What are you thinking about this recent stock market drop?
First I want you to realize that it’s very normal to have these kinds of corrections. When the stock market does not reflect the value of the underlying companies, a correction is needed in order to get to the highs again.
Since we can’t predict these stock market corrections, it is best to see them as an opportunity. An opportunity to check if your current portfolio distribution is right for you.
If you’re feeling extremely nervous, it could be better to switch to lower-risk asset classes like bonds.
When you happen to have some extra cash lying around, you may want to think about investing that as well.
When you’re investing with a long-term horizon, it doesn’t matter what the stock prices are doing this month or this year. You are not selling them any time soon, so who cares?
Second, keep in mind that stocks will go up over time. These companies are a representation of the economy, that will keep growing and growing.
While I don’t know what the stock market will do in 1 or 2 years, I don’t focus on that. Look at the long-term and know that the stocks will most probably appreciate in value in the upcoming 30 years.
Short-term price fluctuations are not relevant to your situation if you don’t need the money in a couple of years from now.
[Related: 11 Truths About Money Everyone Should Know]
When you invest money you don’t need in the short term, you don’t need to worry about the price going up or down this year. You are having a buy-and-hold attitude.
This can release a lot of stress.
If you find yourself worrying too much about your portfolio, do yourself a favor and switch to a more stable asset like bonds.
Invest monthly by paying yourself first, see your money grow, and know that market volatility and market drops are part of the deal.
How do you react to a stock market crash?
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Tim Thomas has no positions in the stocks, ETFs or commodities mentioned.
Featured image credit: Pixabay.