You may have found yourself holding your breath for months, worrying that the stock market might crash. And while it could happen at any time, you shouldn't let the possibility frighten you away from investing.
Pullbacks can be scary, but they are a normal part of an investment cycle. If the thought of a crash has given you cold feet, just remember these three things.
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1. Crashes are inevitable but infrequent -- and unpredictable
A stock market crash happens when there's a significant loss, typically in the double digits. Since the Great Depression, there have only been four stock market crashes in the United States. The first occurred in 1987, the next between the years 2000 and 2002, then in 2008, and the most recent in 2020..
In 2008, the S&P 500 experienced the worst one-year decline since the Great Depression with a 37% loss. But the years since 2009 have mostly been prosperous. We know that at some point, the current streak of market wins will end, but making a wrong guess on when this will happen can cost you money.
In 2020, many indicators like a high stock market capitalization-to-GDP and a high Volatility Index pointed to stocks being overvalued. Despite these warning signs, the drop in March had a quick V-shaped recovery and the S&P 500 finished the year higher than it started. If you sold out of your investments during the year to avoid losses, you would've missed out on these gains.
2. Crashes have always been followed by rebounds
It's been remarkable just how quickly the stock market has recovered from past crashes. Going through a crash doesn't even necessarily mean that the stock market will end up losing money in a given year.
For example, in 1987, the S&P 500 ended up with a 5.2% gain following the worst crash since the Great Depression. Then in 2020, after a painful plunge in February and March, the S&P closed out the year with a 15.5% gain.
To be sure, there can also be years when there isn't a crash but stocks finish out the year in the red, like in 2018, when the S&P lost 4%. But even years when the S&P 500 loses value are infrequent. Since the beginning of 1987, there have only been six years when the S&P 500 has had a negative return. Over this same time period, the index has had a positive return at the end of a calendar year 27 times.
3. You should be invested for the long term
Stock market crashes don't last forever. This means that you should focus on investing for the long term instead of trying to avoid a bear market.
You shouldn't plan on making drastic changes to your portfolio during a pullback. But there are minor tweaks that you can make, like examining your risk tolerance and choosing an asset allocation model that matches your appetite for volatility. This can help limit your losses, which could help you stay invested for the long term.
For example, if the thought of losing 37% of your wealth in a year like 2008 terrifies you, a portfolio made up of 100% large-cap stocks may be too aggressive for you. If instead your portfolio consisted of 50% large-cap stocks and 50% U.S. investment-grade bonds during the 2008 market crash, you would've lost a much smaller amount -- about 16%.
Investing more conservatively does mean that you are giving up potential upside, though. In 2009, when the markets rebounded, this less-aggressive portfolio would've only gained 16% when large-cap stocks gained more than 26%. But if making this small change could help you weather the storm, the trade-off could be well worth it.
Don't sweat the stock market's volatility
Fear of stock market crashes isn't a reason to lose sleep. If history teaches us anything, it's that bear markets happen less frequently than bull markets. So while a crash can be scary, it probably represents a minor blip in your overall investment time horizon. Learning how you can successfully survive one instead of panicking about when one will happen could help give you peace of mind and great long-term returns.
