One day, you may be enjoying an ordinary morning when you check your portfolio and find that many of your holdings are down 5% or more. Yikes! If many holdings are down sharply, there probably isn't much specific terrible news about any particular holding -- instead, it's probably that the whole market, as measured by the Dow Jones Industrial Index or the S&P 500, has dropped sharply.
The more the market drops, the more many investors panic and sell stocks they own. That can send stocks down even more, fueling further selling. It's generally best to not follow the crowd and not worry. Here are three reasons why.
Image source: Getty Images.
1. Stock market crashes often don't last too long
Every stock market investor needs to understand that the stock market is volatile, and "corrections" (drops of 10% to 20%) and "crashes" (drops of 20% or more) will happen -- and not infrequently. The good news is that while these corrections and crashes can sometimes be sharp and severe, they often don't last that long.
A study by Charles Schwab noted that between 2000 and 2019, the stock market dropped at least 10% in 11 of those 20 years (that's more than half of the years!), with an average drop of 15%. (In two other years, the market dropped almost 10%.) That all sounds bad, right? But in fully 15 of those 20 years, the market ended up with a year-end gain, one that averaged 6%. Corrections typically last only about six months.
2. Stock market crashes can be great buying opportunities
The next reason not to be upset at a stock market crash is that it's likely to present some great buying opportunities. As my colleague Brian Feroldi recently tweeted:
My investing mindset:
Stocks Down: Hooray! I can buy my favorite stocks cheaper!
Stocks Up: Hooray! My net worth went up!
The Nasdaq experienced a correction of about 12% recently, falling from 14,153 on Feb. 16 to 12,422 on March 5. If you were paying attention and not panicking, you might have been able to pick up some shares of companies you'd been wanting to buy. Check out how much certain stocks dropped over that period:
|
Stock |
Price Drop |
|---|---|
|
Lemonade |
(41%) |
|
Teladoc |
(35%) |
|
Zillow |
(32%) |
|
Redfin |
(25%) |
|
Tesla |
(25%) |
|
The Trade Desk |
(25%) |
|
Zoom Video Communications |
(24%) |
|
Shopify |
(23%) |
|
DocuSign |
(23%) |
|
Square |
(22%) |
|
Apple |
(9%) |
|
Amazon.com |
(8%) |
|
Netflix |
(7%) |
Source: Yahoo! Financial, with prices from Feb. 16 and March 5, 2021.
Many of these stocks have since recovered much of the ground they lost in that period, making it clear that some corrections really don't last very long and that swift action can be required if you want to take advantage of them. If you do pounce early and nab some desired stocks, understand that they may still fall further for a while and that it could take some years before they're back in the black for you. There are few guarantees in the stock market, and patience comes in handy.
Image source: Getty Images.
3. Stock market crashes are OK if you're prepared
Finally, the last reason not to worry too much about a stock market crash is that you're prepared for it. You may not be right now, but you can take steps to ensure that you're prepared for a future market retraction.
The most important way to protect yourself from market crashes is to not invest any money you'll need in the next five or so years -- or even 10 if you want to be extra conservative. The market can swoon at any time, and you don't want it to take a third of an upcoming down payment with it.
Another smart thing to do is to have a watch list of stocks you'd love to own. I have one, in the form of an online portfolio, and I enter stocks in it at the price they're trading on the day they're added to it. Then, days or months later, I can see at a glance how much they've fallen or risen since I added them. And after a market crash, I can see which ones look most tempting.
You won't be able to pounce on any sudden bargains if you have no cash, so you might consider keeping a small portion of your portfolio in cash, for future opportunities. Don't keep a big portion in cash, though, because the market might not drop for several months or even years, during which time that money won't be growing for you.
Finally, remember to always pay attention to valuation. If you overpay for a good stock, it might fall and take a long time to recover. Cisco Systems (NASDAQ:CSCO) is a great cautionary example. Consider that way back in March 2000, it was trading above $77 per share; it was recently trading for about $48 per share, some 21 years later! It's not that Cisco is a bad company -- there are plenty of reasons to buy shares today -- but when it was at $77, it was simply way overvalued. Aim to buy stocks for less than their intrinsic worth by seeking a margin of safety.
So, try to be more like Brian Feroldi when investing -- enjoy seeing your net worth grow when the market is rising, and get ready to hunt for bargains when it drops. It's a win-win for long-term investors.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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