Many younger shareholders experienced the first real stock market crash of their lives in February and March 2020. Within a short time, share prices around the world plummeted by up to 40 percent. And yet, just one year later, stock markets worldwide were once again storming to new record highs. We saw the same scenario after the financial crisis of 2008/2009. The bottom of the crisis was the beginning of a mega bull market that lasted until COVID-19. So yeah, there might be some basic principles with which investors have always done well in the long run. In this little piece, I want to provide a few guidelines on how I react when stock markets crash. Besides, we apologize for crashing the party a bit because it is not guaranteed that stock markets will recover so quickly every time.
Be aware that you are not alone when the stock market crashes
When the stock markets are shaky, and your portfolio turns red faster than your face at the supermarket checkout when you realize that your credit card doesn’t work, one thought helps: You are not alone in this whole mess. I know that this can be difficult, especially if you have not experienced significant crises in your life. I belong to the generation that only started investing after the Great Recession (2007-2009). The stock market crash in 2020 was therefore an unfamiliar experience for me (we can ignore the comparatively small corrections in 2015 and 2018). It was also the first time me facing a bear market (which didn’t come).
In the case of such extraordinary turbulences, both professionals and private investors are experiencing the same. For the good times and the bad, we are all always in the same boat. So if you think fate has been particularly hard on you, here’s a little gold nugget to cheer you up, taken from Forbes:
“The richest people on Earth are not immune to the coronavirus. As the pandemic tightened its grip on Europe and America, global equity markets imploded, tanking many fortunes. As of March 18, when we finalized this list, Forbes counted 2,095 billionaires, 58 fewer than a year ago and 226 fewer than just 12 days earlier, when we initially calculated these net worths. Of the billionaires who remain, 51% are poorer than they were last year. In raw terms, the world’s billionaires are worth $8 trillion, down $700 billion from 2019.”
Ups and downs are normal
Sure, the years after the financial crisis were pretty rewarding for investors around the world. But it was also one of the longest bull markets, and it was clear that this party could not go on forever. And those who thought they had witnessed a unique crash in February 2020 were sadly mistaken. History is full of such events that had shaken the stock markets around the world. No question, the COVID-19 crash was severe, but it was not even among the top 3. Similarly, the time to full recovery was unusually short.
High liquidity creates high volatility
There are a few reasons why stock prices are so volatile. Firstly, every single share has a price tag attached to it. Secondly, for each share of a company, there are millions of other shares. Finally, stocks and their prices have excellent visibility all over the world. Investors can buy or sell them from anywhere. Accordingly, shares are highly liquid. As a result, investors can easily negotiate the share prices and quickly push them in one direction.
With real estate, it’s different. First of all, each property is a unique item with particular characteristics. The purchase of real estate is also often complex and associated with some regulations. That limits the liquidity of such asset classes. Because of this lack of liquidity, real estate is not an object of wild trading. Therefore, there are no negotiations of many market participants, and accordingly, the price is relatively stable.
So if there is an economic crisis, your house or mine would probably also lose value. We just don’t notice it because no one comes by every morning and puts a price tag in our mailbox.
No need to care about that
The price development of liquid and less liquid assets is thus subject to different volatilities. Still, they are all assets that should preserve and, at best, increase our wealth over the long term. But if we’re talking about long-term wealth management, we don’t need to be interested in how stocks perform every day. There is no need to care about the daily fluctuations in share prices, which is especially true in a stock market crash.
As long as your tenant is paying rent or you can live in your own house, you don’t care if the value of your property fluctuates, right?
The same must apply to shares. As long as companies are making profits, paying dividends, and are financially in good shape, there is no reason to panic. I’ve received good dividends during the COVID-19 crisis. My companies have shown me every month that although times are tough, they still pay their rent. This passive cash flow gave me a lot of confidence and inner peace despite the negative development of my portfolio.
Ignore crash prophets because they are wrong (mostly)
At the height of the COVID-19 crash, in the midst of the lockdown, I spent some time on YouTube listening to supposed experts make predictions. A handful of experts were extremely pessimistic. They saw the end of the financial system coming, especially in Europe. Funnily enough, some of them believed that this crisis would lead humanity into a new era, full of love for our neighbors and mutual care.
Well, I don’t believe that existential crises bring out the best in people. I can show you court decisions about people who threw stones at their neighbors out of fear of the virus. No, in existence-threatening crises, every person is next to himself.
Crash prophets are fun if you have a stable mindset and want to be triggered. Yet, those who prophets can easily influence should give these colleagues a wide berth. Those people are simply negative people who deny a basic facticity of history. They deny progress. This, however, is a big bet against the ordinary course of events. Here is what I wrote in an older article:
“Ever since humans have existed, they have striven for progress and development.
Do you think that after all these thousand years, you will catch the very phase of humanity where this development stops? I think that’s highly unlikely. Regardless of how one views the negative consequences, liberty and capitalism have ensured that people always wanted to go further, to discover (or to create) problems, and to find new or better solutions.
There have always been and always will be mistakes, setbacks, and adverse developments. But in the end, the chances are good that humanity will make further progress. New markets and products, such as cars or cloud computing, will emerge and enable extreme growth in many areas. Be an optimist and look to the future with confidence, especially in times of crisis.”
Yes, crash prophets, like a broken clock, are correct from time to time. I am still waiting for the collapse, though. Anyway, this is not meant to be a rage article against crash prophets. All I am saying is that I keep my distance from them mentally.
A stock market crash makes something physically impossible possible
Instead of embracing doom and gloom scenarios, my mood rises when I see my companies losing value. Sure, I am also happy when they go up (I can’t lose :)), but I am very grateful for corrections, especially in phases of high fundamental valuations. So a stock market crash can become the opportunity of a lifetime because it makes something physically impossible possible.
Enjoying the luck of traveling back in time
In a stock market crash, it is possible to travel back in time and get companies at a price I haven’t seen in years. Maybe a stock was too expensive for me at the time. Perhaps I didn’t have enough capital. In a crash, I get a second chance. The same company I missed out on is back on sale. And that’s a great opportunity – possibly life-changing. So in the COVID-19 crash, I bought in many excellent companies at a price I last saw in 2015 or 2016. At that time, I had much less capital on hand and was upset. The 2020 stock market crash gave me a second chance here.
Additionally, I don’t just get the stock at a price like in the past. Compared with the share price just before the crash, I get a higher initial dividend (yield) as well. So in the best case, such a crash can give your monthly cash flow a real boost.
Yes, I mean it. I smile when stocks go down
For the above reason, I am happy to see stock prices go down. Investors such as Irving Kahn or Warren Buffett have shown that it is possible to build the foundations of future prosperity in crises or recessions. Also, there are good reasons to be happy about a crash with a view to future risk. My thesis is that with every percent of price loss, the risk for new investments decreases. Indeed, shares can theoretically become worthless. But we have to consider that a stock is tied to a company (I wrote about this perspective in more detail in another article, click here). So as long as a company is productive and profitable, a stock cannot fall to zero. Furthermore, a share price decline has a cleansing effect. It cleans a share from all exaggerated expectations and thus also reduces the overall risk.
Eventually, things will pick up again after a stock market crash
My final point to share with you before I throw some salt in the wound is nonetheless the most hopeful: In the end, the stock markets will rise again. Of course, nobody knows what will happen in the short or even medium term. My readers are aware that I don’t practice market timing. Nevertheless, when the dust settles, stock markets will pick up again. They have always done that and will continue to do so. We can also see this in the graph above. It may take time for the stock markets to recover. And yet they do and climb higher and higher peaks.
This reflects my fundamental optimism. Stocks simply mirror economic progress. Anyone convinced that humanity will continue to progress economically will also be optimistic about the share performance. The following chart, which shows the major bear and bull markets between 1929 and 2008, supports this view. We see here that stock market crashes are short and often very painful. But afterward, there were always very long and profitable recoveries. Shareholders who bought in the crash created an excellent foundation for the following bull markets.
So if you’re wondering what to do when the stock markets crash again, I strongly advise you to stay calm and be patient. Especially if you have not been around that long and are now sitting on your first losses, think of the stock market philosopher André Kostolany and one of his many meaningful quotes:
Stock market profits are compensation for pain and suffering. First comes the pain, then comes the money.
Mistakes I try to avoid during a stock market crash
I have already indicated that it is not always as simple as I have described above. Even if I am optimistic, I know that I know nothing. I do not know the future development and the theoretical impact of possible events. Looking at past crashes says nothing about how a future crash will unfold. That makes me cautious. I’d rather miss an opportunity than take increased risk. That is why I have simple to understand but still quite strict criteria, which I do not change even in times of a stock market crash.
I would never ignore the fundamental valuation of stocks on a large scale. There is no “everything is different now”. Investing always remains a business decision. Even in a crash, I would look very closely at the companies. Are they profitable? Do they pay a dividend, or have they cut it? Can these companies still grow? Is the (future) profit in a reasonable relation to the share price? So it’s a question of whether these companies are putting food on the table for my family and me.
That’s why I’m reluctant to make risky turnaround bets on half-dead companies. Here, of course, the potential return is tempting. Nonetheless, I prefer to stay with reliable companies, even if the turnaround potential is lower.
Ignoring risk compliance
Risk compliance is another keyword. I have specific rules regarding diversification, for example. No matter how convinced I am of a company. I would not invest more than 5 percent of my invested capital in one company. This is a rather conservative approach that can cost a lot of returns. This approach also protects me from many risks and cognitive biases (confirmation bias, recency bias, etc.). With my risk compliance, I protect my assets from myself. I will not change that even in a stock market crash.
Rushing and grabbing into a falling knife
Likewise, I try to act calmly and rationally in a stock market crash. I am happy about every correction, but I don’t start to throw all my cash reserves into the market. Fear of missing an opportunity is a bad advisor. Stocks that have once lost 50 percent can quickly lose another 50 percent. The top priority remains to invest money that I won’t need in the next 10 to 15 years. In addition, we have seen in the chart above how long it can take for the stock markets to recover from a crash fully.
The COVID-19 crash was an absolute exception with its quick recovery. It took 25 years after the 1929 crash for a full recovery. That’s brutal. It takes patience, time and perseverance to go through that. Not everyone has that. That is why I visualize the possibility that such a fate could also happen to me. Money that I invest is thus not money that I need today or tomorrow. It is an investment, and I am ready to bear the consequences.
So yeah, I am pretty sure that there is still a lot of pain ahead! But always remember: The stronger the pain, the greater the compensation.
All the best!