Stock Market Crash: What to Do When It Happens
The stock market has shown extreme volatility in the past few months, with much uncertainty abounding factors such as COVID, high inflation, and the war crisis in Europe. While the exact timing of a crash in the market is impossible to predict, the harsh reality is that share prices are bound to face inevitable dips at various points in their lifetime.
Take a look at some ways to prepare for the subsequent market correction.
What to do When the Stock Market Crashes?
Here is how to prepare during a stock market crash:
- Manage your cash flow:
A stock market crash impacts so much more than just the value of a portfolio. It also affects employment, real estate prices, inflation rates, and the list goes on. By maintaining a routine record of cash flow, you can better track and organise your finances, so it doesn’t undermine your ability to handle basic expenses such as rent, utility bills, EMIs, existing debt, etc.
- Have an emergency fund ready:
When the stock market crashes, the vital thing to do is sit back and leave your portfolio alone. But what if an urgent need for money arises and you’re forced to liquidate your investments at a significant loss? It is thus advisable to have a liquid emergency fund that is easy to access. In addition, you would want to cover at least four to six months' worth of anticipated expenses as a rule of thumb.
- Analyse your debts:
A market crash isn't the right time to tack on additional debt to your portfolio, as it runs the risk of trapping you in a critical financial position. However, a market correction can prove to be the ideal opportunity to refinance existing debt in the form of a personal, home, or credit card loan, especially if you have repaid all EMIs without defaulting and have a good credit score.
- Have diversified assets:
When the market dips, your portfolio will likely follow suit regardless of which stocks you own. Moreover, when stocks experience a downturn, specific sectors are affected more than others. Thus, you might be able to minimise your losses by maintaining a diverse portfolio of stocks. You could achieve this in different ways: by gunning for shares across various industries or investing in other long-term instruments such as mutual funds or ETFs.
Moreover, based on factors such as your age, risk appetite, investment approach, and milestones, it is crucial to balance stock purchases with safer investment opportunities. This way, your savings are still intact when you reach retirement despite major market upsets.
- Don't panic-sell:
Selling off your stocks to prevent further losses during a market crash might seem like a good idea. However, historical data clearly indicates that markets have always recovered from stock market crashes. Therefore, it's essential to keep in mind that you invested in a particular company for a reason, so there's no need to worry as long as it shows robust growth and fundamentals. These are the type of companies that tend to perform well over the course of time because they are resilient even in unpredictable situations.
- Research before shopping:
The market being down might seem like the best time to invest at reasonable valuations. Unfortunately, many investors are known to ignore their typical risk appetite in a frenzy and make indiscriminate investment decisions, which can become a hindrance to future goals.
If you're planning to buy during dips, pay special attention to your selection of stocks. Don't fall for investor sentiments and market narratives without reliable confirmation or evidence. Instead, look out for evaluative metrics such as EBITDA, capital allocation, cash flows, and profits, among others. The key is for investors to avoid fundamentally weak or struggling companies and focus on the ones boasting strong balance sheets and great potential at fair valuations.
- Focus on long-term strategies:
It's common knowledge that while the stock market is volatile and risky for short-term investments, stocks enjoy a significant edge over most asset classes in the long run. Given enough time, even the most dramatic drops in value fade in comparison to the upward ticks. Having a long-term vision or strategy in your pocket will make it easier to look at a market decline as an opportunity to create wealth by enhancing your portfolio rather than as a tragic occurrence that will eat away at your savings.
To Sum It Up
A stock market crash can be mentally and economically frustrating for new and experienced investors alike. This is why it's important to understand your risk tolerance, investment horizon, and how the market works during such downturns.
Corrections might be nerve-wracking, but they are not uncommon and tend to pave the way for many future opportunities. Of course, it is unrealistic to assume any control over the market or predict its movements, but you can build strategies for the bear market and respond accordingly. If the situation is too stressful, it’s wise to ask for advice from a seasoned investor or someone knowledgeable you can trust. Remember, you need the patience to become a successful investor.
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Frequently Asked Questions
When stock prices begin to fall at a swift and unexpected rate, it is known as a stock market crash. This can be the result of a financial crisis, natural calamity, policy changes, or a major catastrophe.
When a market is going through sustained price drops amid widespread investor sentiment due to economic policy changes, geopolitical issues, sociocultural factors, etc., it's known as a bear market.
It is often defined by declines in an overall market. Individual securities or commodities can be considered as part of the bear market if they experience a drop of 20% or more over a prolonged period — typically 2 months and above. Bear markets might also be a consequence of general economic ups and downs such as a recession.
The strategy of buying and selling stocks based on market timing is not highly recommended. While simple and straightforward in theory, it can be risky and challenging as it involves getting the timing right on both selling and repurchasing your position. Even the most experienced investors avoid this strategy because it’s impossible to predict the ups and downs of the stock market with enough accuracy.