On the infamous Black Monday of 1987, the Dow Jones Industrial Average dropped 22.6% in a trading session, marking the largest one-day decline in its history. At the time, investors had no way of knowing the market would go on to reach record new highs in less than two years.
The stock market has weathered several major downturns since then, including the dot-com crash of the early 2000s, the Global Financial Crisis in 2008, and the sharp sell-off during the pandemic in 2020.
Each crisis felt like it might never end, but they eventually did. Understanding that is the first step in knowing what to do when the stock market crashes.
Key Takeaways:
- Market crashes can be terrifying at the moment, but history shows that every major US stock market crash has eventually given way to recovery.
- Fear, herd mentality, and constant alarmist media coverage often trigger emotional decisions that cost investors more than the crash itself.
- Rational investors figure out what to do when the market crashes before the event and treat volatility as information rather than a signal to sell.
On the infamous Black Monday of 1987, the Dow Jones Industrial Average dropped 22.6% in a trading session, marking the largest one-day decline in its history. At the time, investors had no way of knowing the market would go on to reach record new highs in less than two years.
The stock market has weathered several major downturns since then, including the dot-com crash of the early 2000s, the Global Financial Crisis in 2008, and the sharp sell-off during the pandemic in 2020.
Each crisis felt like it might never end, but they eventually did. Understanding that is the first step in knowing what to do when the stock market crashes.
Why Crashes Feel Different From Ordinary Volatility
History has a way of putting market turbulence into perspective, but telling investors “just don’t panic” is not useful advice for a few reasons.
Your Brain Is Working Against You
Behavioral economists Daniel Kahneman and Amos Tversky found that people tend to experience the pain of a loss much more intensely than the satisfaction of an equivalent gain. So, for example, losing $10,000 typically feels far worse than gaining $10,000 feels good.
That instinct, known as loss aversion bias, is part of how we’re wired. Understanding this can change how you act when the market crashes, because the fear you feel is a natural response, not a sign that you have made bad investments or that you need to act immediately.
Doing Nothing When Everyone Is Selling Feels Reckless
We naturally look to other people for cues on how to respond in uncertain situations. In investing, however, that instinct can work against us.
Market volatility works like a feedback loop. Falling prices are likely to trigger broad-based selling, this selling accelerates the drop, and the accelerating drop triggers even more selling. Investors watched this play out in 2008 as panic spread through financial markets long after the underlying problems were known.
The same happened with the dot-com bust and the March 2020 downturn. In each case, what happens when the stock market crashes follows a similar pattern.
The News Makes It Worse
It’s also important to remember that financial news is designed to capture our attention, and few things draw our focus like a market crisis does. This means the average investor watching TV when the market crashes might absorb a version of events skewed toward alarm.
Constant coverage makes short-term volatility feel like a long-term reality, even when the underlying businesses and economic fundamentals haven’t changed as dramatically.
Limit the noise to avoid letting it dictate your investment strategies.
What Rational Investors Do Differently
If there’s one lesson from the discussion above, it’s that reacting emotionally often does more harm than good.
But one can’t rely on strong nerves alone. Having a framework that holds up under pressure and knowing what to do when the market crashes before it actually happens is what helps investors stay rational.
Don’t Panic Sell
The first and most important rule is also the simplest: don’t sell based on emotion. A paper loss is only a number on the screen. However, panic selling locks in that loss permanently and removes you from the recovery that follows.
History has repeatedly shown that selling near a market bottom and missing the subsequent rebound can be one of the most damaging decisions for a portfolio, particularly when the investor holds high-quality businesses.
Distinguish Between a Falling Stock Price and a Weakening Business
Rational stock investors also know the difference between a price dropping and a business deteriorating.
Markets are emotional in the short term, which means a fundamentally sound company can see its stock price fall simply because everything else is falling too. That’s a very different situation from a company whose underlying value has genuinely declined.
This perspective brings up another thing to do when the market crashes…
Build Your Strategy In Advance
Perhaps most importantly, rational investors already have a strategy in place that they refer to in times of crises; they don’t figure it out mid-crash.
A disciplined investment philosophy provides a framework for what to do when the market crashes, even if emotions are running high.
For example, at WealthArch Investment Services, our value-investing approach emphasizes maintaining a buffer between a company’s market price and its underlying value. This gives us the confidence that our investments will survive large corrections while also allowing us to be aggressive when prices are low.
Moreover, we work with our clients closely to ensure that they have both an emergency fund and opportunity fund in place.
Identify Opportunities
Protection aside, understanding what happens if the stock market crashes is also about being positioned to act when others are too afraid to.
When a strong company’s stock price drops not because of anything wrong with the business, but because fear is driving the broader market down, it creates exactly the kind of margin of safety that disciplined investors look to invest in.
Protect Yourself From the Next Crash
Again, the best time to prepare for a market crash is before one happens.
Start with your portfolio. A well-diversified high-quality portfolio built around your long-term goals will leave you better prepared for what happens if the stock market crashes.
- Start with your portfolio and your cash reserves. A well-diversified, high-quality portfolio built around your long-term goals can leave you better prepared for a market crash, while an emergency and opportunity fund based on your expected expenses can help you avoid selling investments at the wrong time and give you available capital to take advantage of attractive opportunities when markets decline.
- Know your risk tolerance: A portfolio that keeps you up at night is a portfolio you’ll abandon at the worst moment.
- Keep a long-term perspective: Short-term volatility is the price of long-term growth.
- Avoid investing money you’ll need soon: Capital with a short time horizon has no business being exposed to market risk.
The Role of A Trusted Advisor
Even the most disciplined investor can find it hard to stay the course alone when markets are falling, and headlines are screaming. This is where having the right advisor makes a tangible difference.
Beyond the extensive expertise on what to do when the market crashes, you can’t put a price on having someone in your corner who can provide real-time context and help you make clear-headed decisions.
The WealthArch Difference
At WealthArch, all our clients receive detailed trade email updates, post-earnings commentary, and ongoing communication explaining the reasoning behind key investment decisions. They also have unlimited access to our team at any time.
Understanding what happens if the stock market crashes is far less stressful when you aren’t navigating it alone. Schedule a consultation today to learn how we can help you navigate every stage of the market cycle.
