Here's What I Do When the Market Crashes

What would you do if the stock market suddenly declined by 10% or more? Would you rush to sell in fear of further declines, double down on your best positions, or sit on your hands, waiting for more information? While you might think this exercise is silly, you should know that from a statistical perspective, the market may be riper than you think for an eventual drop. According to The Motley Fool's Morgan Housel, the market drops by at least 10% from a recent market high every 11 months. And while the roughly 6% drop in the S&P 500 back in October was scary, the fact it has snapped back to successive new highs so quickly renews concern.

With this in mind, we asked three of our personal-finance analysts what they did the last time they experienced a market crash. Their stories are below. Hopefully, these will give you insights on how you could better handle a market downturn -- or, at the very least, motivate you to think ahead and plan a strategy.

1. Chuck Saletta
What kept my wife and me investing through the 2008 market meltdown was the most overlooked chapter in Benjamin Graham's timeless masterpiece on value investing, The Intelligent Investor: its chapter on dividends. While many companies, including ones we owned, fell during that period, the strongest ones continued to pay and even increased their dividends. Those dividends told us:

• The businesses were still operating.
• They were still generating cold, hard cash from those operations.
• They were directly rewarding their owners with some of that cold, hard cash.

When the market is falling apart around you, there is nothing like watching the cash from dividends rolling in to help keep you focused on what really matters in investing: the companies behind those stocks. Those dividends had an additional benefit, too, handing us some cash to invest in some of the great opportunities the market was offering up -- without having to sell our existing positions at low prices.

Between the start of 2008 and the bottom of the market in March 2009, those dividends, combined with our regular contributions of cash, helped us pick up investments in these solid companies at reasonable to downright cheap prices:

Split-adjusted purchase data from author's (and his wife's) brokerage accounts. Recent prices from Yahoo! Finance.

Unfortunately, one of my biggest investing regrets between then and now was not holding on to all those companies' stocks all the way through their recoveries. Of them, the only ones we still own are Duke Energy, Spectra Energy, Valero, and L Brands, all of which my wife holds in her IRA.

2. Selena Maranjian
Sometimes there are true market crashes, which are severe, and then there are less extreme corrections and pullbacks. The last time the market pulled back significantly was this fall, when the S&P 500 dropped by more than 5%. Often, when the market drops (as it does with relative frequency), I do nothing.

But other times, I go shopping. That's what I did earlier this fall, as the market was dropping. Note that I didn't wait for it to finish dropping, because a market bottom is only evident in hindsight. Rather, if the market is dropping, it can serve as a nudge to check your watch list and see if any companies you've wanted to buy have fallen to attractive enough levels. If they have, consider buying without trying to time things perfectly.

I ended up buying a few shares of several companies, and now, a few months later, I'm in the red on some and in the black on others -- which is fine, as I'm a long-term investor. One stock, InvenSense (INVN), has crashed since I bought, due to weaker-than-expected quarterly results. Its long-term prospects as a supplier of motion-sensor chips for mobile devices remain promising, though not guaranteed. Another buy, MercadoLibre (MELI 1.54%), is up more than 20% on stronger-than-expected quarterly results. Its e-commerce platform serving Latin America is firing on all cylinders, with its number of registered users, items sold, and payment transactions all growing by more than 20% year over year.

Market crashes have wonderful silver linings in the form of buying opportunities.

3. Alex Planes
Chuck's focus on dividends is sound, and I plan to follow his advice with some of my investable cash. However, I don't believe the next crash will be quite like the last one, with strong companies cratering across the board. A 50% decline is extraordinarily rare in modern market history, having happened only after peaks in 1929 and 2007. A 20% to 30% drop is far more likely -- the Dow has dropped by at least 20% 12 times since the end of World War II, or once every six years or so -- and more modest declines tend to hit high-priced high-growth stocks far harder than defensive dividend-payers.

The most prominent recent example of this phenomenon is the dot-com crash around the turn of the century. Most stocks peaked right at the start of the year 2000, but the fortunes of two defensive dividend stocks and two tech superstars that were all part of the Dow at the time couldn't have looked more different:

Procter & Gamble (PG -0.51%) weathered the storm far better than Microsoft (MSFT 2.54%) or Cisco (CSCO -0.19%), neither of which began paying dividends until after the market bottomed out. Altria (MO 0.57%), the ultimate defensive stock of the past 50 years, not only outperformed the index but produced gains during the downturn. Altria would have been a better buy then, and it's been a better buy ever since, but there were even better buys toward the end of the dot-com crash that only looked brilliant in retrospect:

Amazon.com (AMZN 2.10%) and Gilead Sciences (GILD -0.38%) differed from Microsoft and Cisco in one critical aspect during (and after) the bust that made them far better buys. From the start of the bust through the first year of recovery, they grew far faster, and from a far smaller starting point, than the two tech companies that had already ascended to the top of their fields. Cisco's revenue was essentially flat from 2000 through 2004, and Microsoft's grew by 60%. Meanwhile, Amazon's revenue surged 150%, and Gilead's grew nearly sevenfold over the same time frame. At the end of this impressive growth, Amazon's top line was still less than a fifth as large as Microsoft's, and Gilead had barely cracked $1 billion in annual sales. There was still a lot of growth left.

Some of my money will go toward cheap and reliable dividend-payers, but I'm also compiling a list of high-growth stocks that have a lot of potential but have seen their share price grow faster than their fundamentals. Even more reasonably valued stocks backed by solid and fast-growing businesses -- like Gilead today -- would present compelling opportunities for long-term growth investors in the event of a 20% downturn.