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How to deal with a market crash

| April 01, 2020
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No matter what you want to call it, a bear market, a market crash or something worse, it’s official, the stock market is down a lot in the last month and half. From the all time high of 29,550 on February 12th, the Dow Jones index is down around 21,600 at this writing, about 8,000 points. That’s about a 27% decline from the high, although it was down around 37% before a rally last week.

Wow. It’s hard to wrap your head around that type of move, especially when the economy was strong, unemployment was at a record low of 3.5% and we just had a strong 30% gain in US stock markets in 2019. So how does an investor make sense of this market environment and move forward?

 

  1. Understand that markets are unpredictable: No one could have predicted this crash. Don’t believe anyone who says they did or could have. Markets react to the information that is available at the time and react quickly. If the coronavirus had been contained to China and eradicated, markets would have reacted very differently.

 

  1. Recognize that markets go down on a regular basis: We dislike it and can’t predict it, but since 1928, the S&P 500 has gone down 30% or more 12 different times and gone down 20% or more 20 different times. That means we have to expect a 30% stock market decline about every 7 ½ years. The good news if that despite these regular declines, stocks still have returned over 9% per year on average since 1928. The reward for enduring these declines is earning a better rate of return on your money than a bank account or a treasury bond.

 

  1. Realize that your emotions have a big impact: We are all human and have a built in aversion to losses, whether they are paper losses or not. It feels bad to see your account values decline. Research shows investors “dislike losses” more than they “like gains.” Nothing I write is going to make you feel differently. However, we can recognize that our emotions affect us as investors and build this into our investing plans.

 

Think about why you’re investing. Are you investing for what your account balance will be at the end of this month or in five, ten or twenty years? What will the world look like then? Will companies now be profitable then? What new products and services will exist then that don’t exist now? What will be driving the economy in the future? There’s a good chance it’s a product or service that doesn’t exist today.

 

  1. Think about your investments like an institution does: Most of us are investing for our retirement in one way or another, whether through our 401ks, IRAs or Roth IRAs. That means we are in the driver’s seat of our own personal pension fund. How do pension funds act when markets decline? I’ve never worked for one but I’m fairly certain they don’t sell stocks when the markets decline and try to time when to buy back in. Institutions have a plan for investing and stick to it. They rebalance their investments, buying more stocks when prices are down, selling bonds or other safe investments to keep their investments balanced. Likewise we need to remember to rebalance our investments when markets are strong, selling stocks before declines by having a pre-set rebalancing plan in place, like institutions do.

 

  1. Remember that bear markets end: The average bear market since 1928 has lasted 1.3 years according to First Trust Advisors. The 2008-2009 bear market lasted the average 1.3 years, the 2000-2002 bear market 2.1 years and the 1987 bear market only 3 months. We don’t know how long this bear market will last, but if history is any guide it will end.

When it does end and markets recover will you be prepared to capture the gains of the next bull market or will you be guessing when it is time to get back in? History shows that staying invested and not trying to time the markets is a successful long term strategy to deal with bumpy markets. 

In the words of Peter Lynch, the long time manager of Fidelity’s Magellan fund “The only way to make money in the stock market is not to get scared out of it.”

Here’s to staying patient, calm and optimistic in difficult times! 

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