It might sound silly to talk about a crashing stock market in 2020. After all, the Dow Jones Industrial Average seems to hit a fresh record high almost every day, and there's no sign that things will turn south anytime soon.
However, it's still smart to prepare for the worst -- especially when the market has been on such an amazing run. Many experts are comparing January 2020's stock market to early 1999, and we all know how that turned out. Plus, with the unresolved trade dispute, threat of a global recession, and the uncertainty surrounding the 2020 presidential election in the U.S., there's quite a bit that could go wrong.
With that in mind, here's a simple three-step playbook if the stock market experiences a correction or even a full-on crash in 2020.
- Check your emergency fund and short-term spending plans.
- Don't do anything while the market is plunging.
- Put some money to work while stocks are on sale.
Let's take these one at a time.
1. Check your short-term spending plans now
Here's something you should do on a regular basis, regardless of how strong or weak the stock market is.
Simply put, the stock market isn't a great place for any money you'll need within the next five years. This is true no matter what you think the market is going to do. There's simply too much uncertainty that can move the market in the near term, so there's no good reason to risk your 15-year-old child's college savings or the money you plan to use for next year's family vacation.
The average bear market causes stocks to lose about 30% of their value, and it takes an average of about 22 months before prices recover to their previous highs.
The point is to make sure your spending needs over the next five years or so will be met, regardless of what the stock market does. This could mean moving some of your money into lower-risk assets like CDs, and although you might end up losing out on some returns if the market continues higher, you'll be glad you made this move if things take a turn for the worse.
2. Don't sell while the market is volatile
Now let's get to what you should do if the market starts to plunge. And you might be surprised at this advice.
The best thing most long-term investors can do when the stock market is actively plunging or seems to be moving up or down by several percentage points every day, is nothing at all.
Here's why I say this. We all know that the goal of investing is to buy low and sell high. However, when the market gets volatile, human emotions tend to get the best of us. Our instincts tell us to sell when the market plunges before things get any worse (selling low), which is the exact opposite of what you should do. If anything, volatile times can be a good opportunity to search for bargains, but selling your stocks in response to a market crash is the worst possible reaction.
3. Put some money to work while stocks are on sale
I get it. Bargain hunting with money that's already in your brokerage account is one thing, but it can seem scary to put even more money into the market after you just watched your account values plunge. After all, what if the market drops even more?
This is a common mentality, but that's the wrong way to think about a stock market crash. If you were shopping at your favorite store, and you heard an announcement that everything in the store was 20% off for an unspecified amount of time, would you panic and get out? Or would you hold off on purchasing anything because the discount could jump to 25% or 30%? No -- you'd probably take advantage of the bargains while you could. The same logic applies here.
When stocks are down, it's a great time to max out your IRA or contribute more to your brokerage account. If some of your favorite stocks have declined, it can be a great opportunity to add to your positions.
Simply put, stocks can be scary in the short term, but they always deliver strong returns when you're measuring performance in terms of decades. So, if the stock market crashes in 2020, the best thing you can do is to take a deep breath and keep your eye on the long term.