Stock Market Crash: What You Need To Know To Protect Your Investments
Whenever the stock market reaches new highs, the doomsayers start coming out of the woodwork. “A crash is coming,” they lament. “The market’s going to crash!” But what exactly is a stock market crash? And more importantly, how can you protect your investments in the event of one? Here’s what you need to know.
What Is A Stock Market Crash?
A “stock market crash” is a sharp decline in one or more of the major market indexes in the U.S., which are the Dow Jones Industrial Average, the S&P 500, and the Nasdaq. There’s no specific percentage drop associated with a crash, unlike a correction, which is a drop of 10% or more from the index’s 52-week high. In the past 45 years, there have been 24 market corrections.
Understanding Why Stock Market Crashes Occur
A market crash can be caused by a number of factors. Here are some of the biggest market crashes in the U.S, and what caused them:
The Great Crash of 1929
The Great Crash of 1929 is what most people think of when they think of a stock market crash. The Roaring ’20s, a time of historic prosperity, came to a grinding halt with the market crash of 1929. Stocks had been so actively traded, mostly on margin, that the market simply collapsed, and investors couldn’t pay their margin calls. During this crash, the market fell 12.8% on a single day.
The Stock Market Crash of 1987
The crash of 1987 was caused by a rash of mergers and acquisitions, particularly in the nascent technology sector. This crash saw the market drop 23%.
The Tech Wreck of 2000
The tech wreck of 2000, sometimes referred to as the dot-com bubble, was more of a long, slow drop than a crash. In this crash, a spate of initial public offerings drove prices up wildly, and what goes up must come down. Many companies that went public in IPOs during this time went bankrupt shortly afterward.
The Great Recession of 2008
The Great Recession of 2008 was a crash that was caused by the decline of mortgage-backed securities, which had become a popular investment touted by Wall Street banks. Banks were writing mortgages with no or low down payments, and homeowners began to have trouble keeping up with their payments. As they defaulted, the securities that invested in these mortgages fell, and the market crashed.
The Coronavirus Crash of 2020
The coronavirus crash of 2020 was caused by the global pandemic that swept the world in the early months of that year. The Dow Jones Industrial Average dropped 37% between Feb. 12 and March 23 as businesses closed and unemployment soared. The government quickly stepped in to help, however, and by the end of 2020, the DJIA was actually up 6.6% for the year.
The best advice on what to do in the event of a stock market crash comes from legendary investor Warren Buffett, who said, “Be fearful when others are greedy, and be greedy when others are fearful.” Don’t panic and sell when there’s a crash. Hang on, and, if you can, buy the dip. Prices drop when everyone is selling, so take advantage. Just make sure your portfolio is balanced.
What Happens After a Stock Market Crash?
There is always a lot of hand-wringing when the stock market crashes, but it’s important to keep in mind that after every crash so far, the market has always eventually gone up. This has never been more evident than in the coronavirus crash of 2020. On March 16, 2020, the DJIA closed at 20,188, having fallen from 29,551.42 on Feb. 12, 2020. On July 26, 2021, the Dow closed at 35,144.31.
Protecting Your Investments in a Crash
Just like you wear a seat belt to protect yourself in the event of a car crash, there are steps you can take to protect your investments in the case of a market crash. Here’s a three-step plan:
- Make sure your investments are diversified. Some crashes are led by a single sector, like the tech wreck of 2000. Investors who had all their money in shiny new technology stocks took a far bigger hit than those who had at least some money in more traditional companies. Your portfolio should reflect different sectors, industries, geographies and company sizes.
- Rebalance your portfolio regularly. When a certain sector is on fire, it’s tempting to ride the wave. But if you don’t rebalance regularly, you could find yourself with an outsized allocation in a vulnerable sector. Review your investments at least quarterly to make sure you’re diversified the way you want to be.
- Don’t panic. This bears repeating — if the market crashes, avoid the temptation to jump on the bandwagon and sell. Staying the course is often the most prudent strategy.
Investing is risky, but it’s also rewarding. Understanding the risks and having a plan to deal with them can help you live with the risks so you can enjoy the rewards.
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- Charles Schwab. 2020. "Market Correction: What Does It Mean?"
- TheStreet. 2020. "Biggest Stock Market Crashes Throughout History."
- Forbes. 2021. "The Coronavirus Crash Of 2020, And The Investing Lesson It Taught Us."