What Happens When the Stock Market Falls?
Let’s simplify it with a real-life example:
Nakul senses it. Panic pervades the streets. The news has spread that we are in the midst of a stock market crisis, and mass hysteria has resumed. The negative news is prevalent on television, the internet, and social media. Similar to previous market corrections, market players believe that the current decline may be permanent and that the market would not recover. Nakul began trading in the stock market only two years ago. He had been investing in huge, high-quality firms and was sitting on a healthy profit and portfolio until the latest market correction. He is now in a state of panic and seeks advice on his next steps.
The unpleasant reality is that investors tend to pump money into equities during bull markets — when stocks have been rising for a while and the news is exaggerated as if nothing could possibly go wrong with the markets. Due to a fear of missing out, several small investors pile on. The same investors panic and flee at the first sign of a correction. By purchasing at a premium and selling at a discount, they incur significant losses. Nakul would do well to recognize that, as a basic rule, he must avoid financial news to be successful at investing. In order to avoid making rash decisions, he must tune out the background noise.
Across time periods and market cycles, research has demonstrated that investors with substantial assets tend to ride out the market and are unconcerned with short-term fluctuations, whereas investors with smaller amounts of assets tend to lock in losses by removing assets from the market during lows. When and if they are able to reenter the market, they will have missed out on several days of significant gains, and the vicious cycle will continue. Therefore, rather than selling during a downturn, it is preferable to buck the trend.
Nakul must follow the advice of the world’s greatest investor, billionaire Warren Buffett: “Be frightened when others are greedy, and greedy when others are fearful.” There is no reason for Nakul to fear unless he is closer to a long-term financial objective, such as retirement, buying a house, etc. Buying more stocks should be the last thing he wants during a stock market crisis. Moreover, how does one tell whether the market is nearing its peak or trough? The reality is that no one does. The optimal strategy is to make regular, planned investments, regardless of market conditions.
Why Shouldn’t I Panic?
When the stock market falls and the value of your portfolio drops dramatically, it is tempting to question yourself or your financial advisor (if you have one): “Should I withdraw my money from the stock market?” This is understood, but it is most likely not the wisest course of action. Instead, you may wish to inquire, “What should I not do?”
Economic recessions and stock market collapses are a fact of life. As the COVID-19 outbreak demonstrated, market catastrophe can appear out of nowhere. What matters is how investors respond to that catastrophe. Although it is hard to foresee when a market will crash or correct, there are a number of tactics investors can employ to lessen the impact on their investment portfolio.
Here Are A Few Things To Think About When The Market Is Volatile.
- Stay aware and make a plan
The most crucial thing to keep in mind is that a bear market typically lasts a short while. If you’ve never made a financial plan before, take some time to sit down and review your whole financial status before making any investing decisions. Determining your objectives and risk tolerance is the first step to effective investing. You can do this on your own or with the help of a financial expert. How long a bear market will last potentially be predicted by following financial news and updates
- Identify good value stock
Robert Kiyosaki says, “Crashes are the best time to get rich.” Crashing markets provide the best investment opportunity, so maintain a watchful eye on attractive value stocks. Value stocks are companies that are currently trading at a discount to their intrinsic value and will thus deliver a greater return.
- Make an investment strategy
Diversification prevents you from losing all of your assets in the event of a market downturn. To diversify, you must have multiple types of investments. This necessitates the ownership of stocks, bonds, real estate funds, overseas securities, and cash. After dividing your funds into several parts (five or ten, for example), you should invest (maybe once a month). It will benefit you in averaging out your buying in the longer run (Rupee Cost Averaging).
- Stay invested in a long-term portfolio
Stock markets have always experienced peaks and valleys in the past. Not only is it fundamental to markets, but it also contributes to their development. Bear in mind that this too shall pass, and the markets will rebound. It is essential to maintain an investment portfolio, but the quality of the portfolio is of utmost importance. The majority of equities are likely to decline during a bear market, but not all will recover. A long-term investor should not sell a holding in which they have invested. Some investors sell their assets in the hopes of purchasing them at a reduced price in the future. No one can forecast the bottom of the market, making it impossible for investors to repurchase their stocks. Therefore, it is preferable not to sell them during a market decline.
- Equity investment
Investors can reduce their debt holdings and raise their equity weighting, as investing at a low price always yields higher long-term returns. A stock market fall typically presents the perfect opportunity to boost your equity allocation at a cheap cost and convert from a conservative to an aggressive asset allocation. This is owing to the historical unmatched potential of equity investments, especially when acquired at cheap values, to increase investment returns for long-term goals such as retirement.
Understand Your Risk Tolerance
Investors can likely recall their first encounter with a market decline. A sudden drop in the value of inexperienced investors’ portfolios is disturbing, to say the least. When constructing your portfolio, it is crucial to understand your risk tolerance in advance, not when the market is in the midst of a downturn.
Your risk tolerance is determined by a lot of factors, including your investing horizon, monetary needs, and emotional reaction to losses. It is typically determined by your responses to a questionnaire; numerous financial websites offer free online quizzes that can provide you with a sense of your risk tolerance.
Important in assessing your risk tolerance is the time horizon of your investments. For example, a retiree or someone nearing retirement would likely wish to maintain their savings and earn income in retirement. These investors could invest in stocks with low volatility or a portfolio of bonds and other fixed-income instruments. However, younger investors may invest for long-term gain because they have ample time to recover from bear market losses.
Prepare For—and Limit—Your Losses
To invest intelligently, you must understand how the stock market operates. This allows you to evaluate unanticipated declines and determine whether to sell or acquire more.
Ultimately, you should be prepared for the worst-case scenario and have a good plan in place to mitigate your losses. If the market crashes, investing just in stocks could cause you to lose a considerable amount of money. To hedge against losses, investors make alternative investments deliberately to lessen their exposure and risk.
Lowering risk entails a risk-return tradeoff, wherein the risk reduction diminishes the possibility of earnings. Diversifying your portfolio and utilizing alternative investments, such as real estate, that may have a low connection to equities, can mitigate downside risk to a significant degree. Diversification consists of having a portion of your portfolio invested in stocks, bonds, cash, and alternative assets. Depending on your risk tolerance, time horizon, objectives, etc., you will allocate your portfolio differently based on your circumstances. A well-executed asset allocation strategy will allow you to avoid the risks associated with placing all of your eggs in one basket.
Focus On The Long Term
Numerous volumes of data historically demonstrate that although short-term stock market returns can be highly volatile, equities outperform virtually every other asset type over the long term. In the context of the market’s long-term rising tendency, even the largest declines appear to be minor blips over a suitably enough time frame. Especially during volatile periods when the market is in a considerable downturn, this aspect must be kept in mind.
Having a long-term perspective will also allow you to view a significant market decline as a chance to develop wealth by increasing your holdings, as opposed to a threat that would wipe out your hard-earned money. During major bear markets, investors sell equities regardless of quality, offering an opportunity to purchase certain blue chips at reasonable prices and valuations.
Consider Rupee Cost Averaging if you’re afraid that this strategy may resemble market timing. Using rupee cost averaging, the expense of owning a specific investment or asset, such as an index ETF, is spread out over time by purchasing the same rupee amount of the investment at regular intervals. Due to the systematic nature of these periodic purchases as the asset’s price fluctuates over time, the end result may be a lower average investment cost.
If the Stock Market Looks Like It Could Crash, Should I Sell All My Stocks and Wait to Buy Them Back When the Market Stabilizes?
This “market timing” approach may sound simple in theory, but it is exceedingly difficult to implement in fact since you must precisely time two decisions: selling and then repurchasing your positions. By liquidating all of your holdings and converting them to cash, you run the risk of leaving money on the table if you sell too soon.
As for re-entering the market, the bottoming-out process for equities often occurs amid a plethora of unfavorable headlines, which may cause you to second-guess your purchase decision. Consequently, you may wait too long to reenter the market, by which time it may have climbed substantially. The key to successful investment, as most seasoned investors will tell you, is time in the market, not (market) timing, because missing the market’s best days, which are impossible to foresee, is extremely harmful to portfolio performance.
Do Bonds Go Up When The Market Crashes?
Generally, but not always. Government bonds, such as Treasury Bills, perform best after a market crisis; riskier bonds, such as junk bonds and high-yield loans, suffer worst. The Treasury market benefits from the “flight to quality” phenomenon that occurs during a market meltdown, when investors migrate to perceived safer investments. In a bear market for equities, bonds also outperform stocks because central banks prefer to reduce interest rates to support the economy.
Should I Invest In The Stock Market If I Need The Money Within The Next Year To Buy A House?
Unequivocally, no. Investing in the stock market is most effective if undertaken with a long-term perspective. In a bull market, investing in stocks for less than a year may be enticing, but markets may be highly volatile during shorter time periods. If you need funds for a down payment on a home when the markets are down, you risk having to liquidate your stock investments at the worst possible time.
Conclusion
Almost no one can anticipate when the market will crash. However, how you manage the impact of a crash on your investments is entirely up to you. Staying invested and continuing to invest (assuming you are in good quality stocks or mutual funds) is a better option than writing off equity entirely.
FAQ
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What is a stock market crash?
The stock market crash is described as a sudden and unexpected drop in the stock market’s broader set of stock prices.
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Is a market crash an opportunity to buy more stock?
Investing in stock when equity prices are low is a sound trading strategy. However, extensive research is required before investing in any stock or equity.
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What mistake should I avoid during a market crash?
Panic selling is something one needs to avoid during a market crash. Have a sound strategy beforehand with a long-term horizon.
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Should I stop my SIP?
Equity as an asset class might be volatile in the short term, but it can potentially build wealth over time, regardless of market cycles. Continuing SIPs is a sensible plan, especially if you have a longer time horizon in mind. Moreover, SIPs let you gain during volatility by buying more units when prices are low and less when prices are high.
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