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How To Take Advantage Of A Stock Market Crash
There’s an old saying on Wall Street: If you don’t sell it, you haven’t lost it. In other words, the value of your investments doesn’t really matter until the day you need to cash out, so don’t worry about the ups and downs in the interim.
That’s cold comfort when your portfolio has lost 20% or even 30% of its value in a stock market crash. Just look at the market this month and you’ll know what I mean—or think back to early 2020 when the Covid-19 pandemic began.
Market crashes are inevitable and they really hurt. So what should you do when there’s a crash? Make the best of it—here’s how.
1. Do Nothing During a Market Crash
If you believe in your investing strategy and your current portfolio assets, don’t change your plans unless you have a good reason. When you built your portfolio, after all, you might have had a market crash just like this one in mind.
People who panic sell during a crisis often regret their choice. Take those who jumped ship in spring 2020, when the S&P 500 fell over 30% in a very short period. They were already regretting their moves by summer 2020, when the early Covid market losses had been erased by the lightning-fast pandemic rally. And by the end of the year? They had missed out on 65% gains from the bottom of the crash.
2. Go Shopping During a Market Crash
Market crashes are frequently the result of events like the emergence of Covid-19 or the news that the Federal Reserve will change its monetary policy strategy. To make matters worse, rapid market declines can trigger forced trades by aggressive speculators who have borrowed money to buy stocks and are now subject margin calls further liquidating their stock holdings, leading to a cascade of selling.
But here’s the thing: A market crash creates opportunities, especially for savvy investors. You may be able to splurge on stocks and funds you’ve had your eyes on at steep discounts—or you can simply continue buying shares on your regular investing schedule.
The best place for novice investors to start is index funds, says New York-based certified public accountant (CPA) Paul Miller. “Buy them on a regular pattern, consistently. Then go to sleep at night,” he says.
3. Dollar-Cost Average, Even on the Way Down
When the market is in turmoil, the safest way to go on a buying spree is to dollar-cost average your purchases. That means making purchases of a set dollar value at regular intervals, even when the market looks scary.
Dollar-cost averaging smooths out ups and downs of your average purchase price, often lowering it over the long term. Spreading your buys out this way reduces your risk since you won’t be investing all of your money when the market is at a particular price point. Hopefully, that helps free you of that “what if the stock gets crushed tomorrow?’” fear.
If you are investing through a workplace retirement plan, dollar-cost averaging happens automatically. If you’re investing on your own, whether that’s in a taxable investment account or a tax-advantaged individual retirement account (IRA), your brokerage should have a feature for you to automate your contributions.
4. Hunt for Dividends during a Stock Market Crash
For the slightly more adventurous, down markets can be a good time to consider letting dividends drive your investment choices. Many companies share their profits with shareholders through a small dividend yield annually, a bit like banks pay interest to savings account holders.
While dividends aren’t guaranteed, and they can change, companies that issue dividends tend to be more mature and their share prices are less volatile—and, as long as the dividend is paid out, there’s always some gains. This means dividend investing can be a smart move during market downturns when share prices and returns may otherwise be falling.
5. Ride the Sector Rotation
A time-honored strategy for dealing with market downturns is to move money from one stock market sector to another. During times of high growth, for instance, tech stocks seem to do well. When the economy slows, meanwhile, “boring” sectors like utilities stocks tend to hold up better. So if you strategically move from one to the other, you may avoid large dips in one particular sector.
But not everyone is a fan of so-called sector rotation.
“I’m not much into sector rotation. It’s another form of timing the market,” says Kansas-based certified financial planner (CFP) Desmond Henry. “You have to time when to get in and when to get out. I remember when all those stay-at-home stocks became a big deal, but by the time that trade caught on, it was too late. And even if you time right going in, when do you get out?”
You can avoid this challenge and maintain solid returns by purchasing diversified index funds, which may do well no matter which way a particular sector goes. If you own all of the market to begin with, you’re already poised to benefit from any of its sectors’ growth, which can help prop up other sectors flailing in the short term. See our list of the best total stock market index funds for more ideas.
6. Buy Bonds during a Market Crash
Down markets are also a chance for investors to consider an area that novice investors might miss: Bond investing.
Government bonds are generally considered the safest investment, though they are decidedly unsexy and usually offer meager returns compared to stocks and even other bonds. Still, during times of uncertainty, holding some government bonds can make it easier to sleep at night, given their history of flawless repayment.
Generally, government bonds must be purchased from a broker, which can get pricey and complicated for many individual investors. Many retirement and investment accounts, however, offer bond funds that contain many denominations of government bonds.
Don’t just assume all bond funds are stocked with safe government bonds, though. Some also contain corporate bonds, which are riskier.
7. Cut Your Losses during a Crash (and Save on Taxes)
Despite our advice above, sometimes cutting your losses is the smartest investing move you can make.
Not only does it free up money that you can then invest differently, but, provided you’re investing in a taxable account, it also allows you to claim your losses on your taxes. This investing strategy, called tax-loss harvesting, lets you offset income with losses you realize, which may lower your tax bill.
It’s best to speak with a tax professional before you engage in this strategy to make sure you avoid what’s called a wash sale, which happens if you buy an investment that’s too similar to the one you sold at a loss. You may also consider having a robo-advisor manage your investments for you.
Note that the best robo-advisors already have tax-loss harvesting features built into them.
8. If You Are Retiring Soon, Tread More Carefully
One group of investors who have something to fear from a stock market crash are those facing imminent retirement. It’s a huge bummer to start drawing down retirement savings during a bear market.
But if you’ve planned out your retirement carefully, you’ll likely be able to avoid the harshest effects and anxieties of a downturn. Remember: While you start aggressively when you save for retirement, you’re ideally shifting to increasingly conservative, bond-based holdings to preserve your savings as you age.
You may even employ a bucket strategy that keeps at least a few years of living expenses in cash to fully protect your lifestyle from extreme market dips.
Having the cushion to keep some of your nest egg invested helps you benefit from future market recovery and growth. This can be invaluable for long-term investors of all ages, including those already in retirement.
Yep. That’s right. You can still be a long-term investor in your golden days. If you’re in your mid 60s, you could have two or three more decades to benefit from investment growth. While that’s helpful for all retirees, it’s especially important for people who are on less solid financial footing to keep in mind so they can minimize future shortfalls.
If you’re years or decades from retirement, start planning now how you’ll adjust your asset allocation as you age so you’re prepared no matter what the market brings. And if you’re closer to retirement than from it but didn’t have money set aside before a market crash, don’t panic. Set up a meeting with a financial advisor so you can walk through all of your options.
