To The Moon

Is the stock market going to crash? Who knows? Depending on which forecaster you follow the answer is maybe yes, maybe no. One thing is certain, however, the market’s going to fluctuate. In any event, it’s better to be prepared for a crash, just in case.

There’s no specific definition of a crash. The regulators may halt trading for 15 minutes if the S&P 500 drops 7% or more in a single session, and this has not happened often. The best we can do to define a crash is: a severe and sudden drop in stock prices. The good news is that this is usually followed by a bull market.

The most famous crash was in 1929. (Contrary to popular belief, it did not cause the Great Depression; but that’s a topic for another article.) The market took about 20 years to recover. Other crashes occurred in 1987 (down 25%), 2000 (dropped 50% and took 7 years to recover), 2008 (down about 50%, recovered in 2 years), and most recently, 2020 (due to the pandemic the market fell more than 30% but rebounded in less than a year).

If you have a long investment timeline and are properly diversified, it’s often best to ride out the downturns. And understanding that a crash could happen means you can plan for it and react thoughtfully. Here’s a game plan for what to do when (and before) the market crashes.

1. Review why you originally bought each investment that you own. As you look at the reasons on the positive side are there negatives piling up? Is your perfectly good investment having a bad day and still worth holding? Remember that eventually the stock market historically has recovered and gone on to higher ground.

2. Are you properly diversified? Stock vs. bonds is one form of diversification. But don’t ignore diversification across industries. This gives some protection if one industry (such as retail sales) is doing poorly, but other industries are not performing as badly. Diversification can reduce your risk and make the bumpy downturn a little smoother. If you’ve carefully invested in mutual funds, you probably have already established a good measure of diversification.

3. When the market crashes, you will find many instances where stocks are selling at bargain basement prices. Prepare for this by always having some cash on hand and having a list of stocks you’d love to own if only the price was lower. You may not buy at the absolute bottom (few are that lucky), but that’s okay. Another way to buy in is by using dollar-cost averaging. This way you space out your purchases and may get a better buy-in price.

4. If you have a personal investment broker or advisor and he (or she) is someone whose advice you trust, be sure and check to see if you can get another reading about the state of the market. Psychologically, you are probably experiencing a lot of negative feelings about yourself. It’s a good idea to have someone to calm you down and build up your confidence that things will get better. The broker or advisor can review your portfolio and make suggestions about what (if anything) you can do before the market turns around.

5. Remember you’re in the market for the long run. In the short run it may be very depressing to watch your investments drop in value, but one day the clouds will clear, and the sun will come shining through like it has every time in the past. Also, if you sell in a down market, you’ve locked in your loss. You may end up buying back your investments at a higher price later on when the market recovers.

6. If you have a traditional IRA or a 401(k), a market drop may be the ideal time to convert some or all of it into a Roth IRA. You must pay tax on the money converted, but that’s the last tax you will pay on that money. Your investment will grow tax-free and future withdrawals from a Roth account can be tax-free. Be sure to consult with a professional before making this move to be sure you are aware of all the consequences.