After falling about 35% in barely over a month, the S&P 500 has rallied more than 20%. That's made up a lot of lost ground, and believe it or not, the S&P 500 is only down about 13% from its high as of this writing.
There's possibly more pain to come, though. We've seen record numbers of people file for unemployment, more than 90% of Americans are still under stay-at-home orders, and millions of businesses have closed. All the volatility and uncertainty about what stocks will do next has plenty of people wondering what to do with their money.
How do you know when to buy stocks during a sell-off? A good starting point is to have some guidelines in place to follow, as well as a solid investing plan that's based on both your short- and long-term goals. Simply having a plan you can act on can go a long way toward helping you succeed during these uncertain times.
Do this first
Before you start aggressively buying stocks during a market crash, make sure your immediate needs are covered. Even if your job seems secure, having a cash safety net that can cover at least three months of living expenses is more important.
Once that's covered, however, it's time to get greedy.
Make sure you're ready for more losses
The current environment is a textbook example of why you shouldn't expect to make a quick buck and risk money you'll need in the next few years in stocks. Six months ago, there's no way anyone could have foreseen the global economy coming to a screeching halt to limit the spread of a deadly virus. It's likely that millions of people who were close to retirement may have to delay that decision because they were overexposed to stocks and won't be able to afford to retire.
This isn't just about not risking money you can't afford to lose in the short term to market volatility. It's also a warning that you'll need to go into this with the right mindset. Stocks have done incredibly well over the past decade, but it took more than five years for the market, as represented by the SPDR S&P 500 ETF (NYSEMKT:SPY), to recover all of its losses:
The most important time to buy stocks
Before stocks started falling in earnest in late February, the prior decade had been unprecedented in the length of the bull market run with minimal interruption. Since the market started recovering from the global financial crisis in 2009, 2018 had been the only year the S&P 500 lost money in total returns.
There's a valuable lesson to glean from this bull run: Stocks spend more days going up than they do going down, and waiting for the next big crash to buy can cause you to miss the best gains. Since the market's bottom in March 2009, the S&P 500 is up an incredible 420% in total returns, even factoring in the ongoing crash.
Can you imagine being the person who sat on the sidelines for the past decade waiting for the next big crash to buy? Even investors who bought at the pre-Great Recession peak in late 2007 -- the absolute top before stocks fell almost 60% over the next 1 1/2 years -- have enjoyed wonderful returns over the past dozen years:
As a starting point, successful stock investors follow this first guideline: Don't wait for a market crash to buy. Invest in good and bad markets.
When to buy stocks during a market sell-off
That's not to say you should skip out on the opportunity to buy when stocks crash; just don't think you have to wait for big downturns or even big drops. For instance, we see a 10% drop about every two years, a common enough occurrence to keep a little cash ready to take advantage of.
Sometimes, the market keeps falling, but 20% and greater declines are so rare that it doesn't pay to set aside a large amount of cash to wait for that to happen. Over the past 50 years, the S&P 500 has lost 20% 11 times, while 30% or more declines have happened about half as often. Market drops don't follow a schedule, either. We went almost a decade between 20% drops, then got two in less than 1 1/2 years, one of which turned into a rare 30% crash.
With these numbers on our side, we can formulate a basic strategy to take advantage of various levels of a market crash. Here are the general guidelines I follow for when to buy during a crash, and how much cash I keep on hand to deploy:
- 10% drop: Deploy about half my cash reserves into my best ideas.
- 20% drop: Deploy about half of what's left over into my best ideas.
- 30% drop: Deploy about half of what's left over into my best ideas.
The guidelines above are built on the fact that 10% declines are the most common, and stocks tend to rebound quickly from those drops. By acting aggressively to deploy my "market-crash" cash reserves (which is about 5% of my portfolio), I can make the most out of the most common market correction we see. It's important to note that this is on top of my regular, ongoing investing.
Invest even more when you can
So there you have it -- a basic framework to help you know when to buy stocks when the market is crashing. By following these guidelines, you'll take advantage of the typical and most common 10% drop to juice your returns, while still having some cash on hand in the rare instances when stocks fall more, and the even rarer times they fall 30% or more.
Don't have as much cash on hand as you'd like to invest in the current market crash? The best way most people can take advantage of the ongoing downturn is to crank up their 401(k) contributions. Even if it's only a temporary increase, buying more of those funds in your retirement account while the market is down will pay off over the long haul.