How not to panic when the stock market crashes

How not to panic when the stock market crashes
July 26, 2018 Editorial Team
Image depicting person when stock market crashes

Stock market crashes are a regular occurrence

A stock market crash is when a stock index (the ASX, S&P 500, the NASDAQ or the Dow Jones) drops severely in a short space of time. A correction is more gradual and occurs when the market drops 10 percent from its 52-week high.

Since 1900 there have been at least 29 stock market crashes around the world and on 5 February 2018 the Dow Jones plummeted by almost 1,600 points. Some economists and commentators are presently bearish regarding the global economy and, given this possibility, it is important to have a plan in the event of your investment portfolio declining.

Firstly, don’t panic. If you have built a diversified portfolio, designed for long-term growth, resist the urge to sell, be patient and understand that there is likely to be a rebound in time. Warren Buffett, arguably one of the world’s most successful investors, states “The stock market is a device for transferring money from the impatient to the patient”. When prices drop significantly many investors join the herd and sell, which feeds the cycle.

Secondly, consider buying if you can. A crash, or correction, has historically allowed investors the opportunity to find good quality businesses selling at a large discount to their intrinsic value. Research is a key component to building a strong and diversified portfolio that will weather the storm of a crash more successfully. Ensure that you understand the business, its debt levels and potential future growth and buy it while it’s on sale. Chances are you won’t see that price again.

In the meantime:

  • Consider reducing any leveraged positions. Psychologically debt during a downturn is more likely to cause, or force, an investor to panic sell. Furthermore, a highly leveraged portfolio can be value-destructive, especially if you are forced into margin sales
  • develop a strategy around your investments so that it aligns with your goals
  • endeavour to create a portfolio that can be left untouched for an extended period of time should a crash occur, and
  • rebalance your portfolio as market conditions, and your requirements and appetite for risk, change.

Your objective should be to create a portfolio that you can hold on to during any downturn, as you are confident in its long-term recovery.

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