6 Things To Know About Stock Market Crashes and Downturns

The regularity of market crashes and declines is a reminder that patience is key to investing in equity markets.‌

From December 2021 through mid-June, the U.S. equity market was down about 20% in real terms.‌

Lessons Learned From Stock Market Declines

1) From time to time, stock markets go through long and deep periods of decline.

2) After a large decline, it is hard to predict how long it will take for stock markets to recover.

3) Over the very long run, stock markets have been very generous to investors who can get through long periods of decline.

4) During times of a rapid and deep decline, investors should avoid panic selling.

5) The standard bell curve is an inadequate model of stock market returns. A model that can capture the extreme risks of the equity market (its “fat tails”) is needed.

6) Sometimes, the market and economy move in opposite directions.  

Lessons Learned From the History of Stock Market Crashes and Downturns

At the time of a market crash or downturn, of course, we couldn’t have known that would prove to be the case—which is why some investors panicked and sold off their stock holdings.

It just goes to show the unpredictability of markets. Not all crashes are alike in their severity and duration, and naming the market’s peak or bottom is difficult. Therefore, the best bet is to prepare now for the next crash by owning a well-diversified portfolio that fits one’s time horizon and risk tolerance.

 “Market risk is about more than volatility. Market risk also includes the possibility of depressed markets and extreme events. These events can be frightening in the short term, but this analysis shows that for investors who can stay in the market for the long run, equity markets still continue to provide rewards for taking these risks.”

Equity Investing Can Be Quite Rewarding, But One Must Understand the Risks

One reason the risks and potential awards of equity investing are often misunderstood is that standard models of equity returns are based on the bell curve.

In a bell-curve model, it is virtually impossible for there to be the sort of extreme returns that are largely responsible for the deep declines and large runups that we see in market history. In other words, bell-curve models lack the fat tails (the extreme returns on the ends of the curve) that we see in historical returns.