As you have likely come to find, markets are volatile and, in a way, there are distinct market life-cycles that occur over time. As such, markets go through great periods of growth — during which investors are happy and mostly all things related seem to be going well. In contrast, they also go through periods of rescission, which escalate to crashes from time to time. To understand market crashes and how to prepare for them, it is first important to be able to identify a crash. Moreover, this is the case because not all market downturns are considered crashes.
In fact, most of them are normal occurrences of volatility (a drop of roughly 10% is considered to be a simple correction). Generally, though, most investors do not start paying special attention to such movements until the market drops (or looks like it will drop) 20%+. At that point, the market is considered a “bear market,” but even then, the negative movement has not been severe enough to be labeled a crash yet. Once a market experiences a drop in the 35-60% range, though, investors tend to slip into a panic-mode because conditions for a true crash have been met. For reference, such crashes occurred in the United States during the internet bubble between 2001 and 2004 as well as the 2008 bankruptcy of Lehman Brothers. Understandably, during market crashes, people tend to worry about their investments — often for good reason. However, with preparation, it is possible to keep your investments on track and make it through tough times without taking major hits. Here are a few tips that might be able to help you get started:
This has been covered in multiple other articles, but it cannot be stressed enough. If you want to build up a strong portfolio that achieves continued earnings in the long-run, it is crucial that you establish some type of diversification strategy. Furthermore, while the actual investments you make are up to you and should come from your own research, a few common types of diversification include the use of varying asset classes, multiple industries, and different geographic locations. Remember, regarding types of investments, you have tons of choices (including but not limited to) stocks, bonds, real estate, options, ETFs. Likewise, there are hundreds (if not thousands) of industries to choose from. Keep in mind, one type of investment or industry crashing does not necessarily mean that there isn’t another that is booming with success. Market crashes can even become great investment opportunities in some instances!
Rebalancing Your Portfolio:
As pointed out above, a market crash does not always mean that all types of investments have crashed. As result, with some good strategy, you can sometimes use crashes to your advantage. For example, if stocks began to crash across the board but other assets you owned became stronger (bonds for instance), you could take the earnings from the stronger asset class and use them to buy more stocks at a lower price. Consequently, you would be buying stocks closer to their “bottom” — giving you the opportunity to make significant gains when the market recovers. While this is not foolproof, meaning it will not work in every instance, it does showcase the use of a rebalancing strategy that you might want to consider the next time the market takes a dip.
Be Patient and Focus on the Long Term:
It is no secret that most people are not great at being patient. In fact, many people despise situations where they need to be patient. Nevertheless, when dealing with a market crash, sometimes being patient is what you will need to do (even if it seems so simple). In addition, thinking about the long-term might help— as it will likely promote mental recovery and provide the motivation to keep your spirits high through financial turbulence. Fortunately, in the United States, there has never been a permanent crash across all markets. Better yet, over its entire lifecycle, the financial markets have had a consistent upwards trend — it has just taken time. For instance, it took roughly 17 months to make it through the crash that began in September of 2008. Eventually, though, there was a bounce back.
This article does not serve as a magic solution to avoid financial losses during a market crash — this is mainly because there is no magic solution. That said, and as with most events that force you to face adversity, being proactive and prepared can give you the knowledge and tools necessary to overcome the challenge. Ultimately, there have always been some winners during tough economic times even when it seems like everybody is losing. Through the right amount of studying and execution, maybe in the future one of those winners could be you. As an aid, remember to diversify, consider rebalancing your portfolio, and practice remaining patient with a positive long-term mindset!