If you invested in January 2009, you would've started your investment journey toward the beginning of the longest bull market in history. And your investment in the S&P 500 would be up by 467% since then!
After such a long run of mostly gains, the thought of a stock market crash could be terrifying. But when investing, a period of losses is normal. Rather than being afraid of this eventual outcome, you may fare better if you prepare for it by doing these four things.
Learn about stock market crashes that happened before
Accumulating your wealth can take years. And if the stock market crashes, you can lose a large sum of money in a short period of time. But those losses are temporary and if you can stay invested, you should earn everything back.
The last three stock market crashes happened in 2000 through 2002, 2008, and in March 2020. If you owned large-cap stocks in 2000, you would've suffered losses totaling 43% over the next three years, but by 2006 you would've been made whole if you stayed invested. If you held large-cap stocks in 2008, you would've lost 37% of your wealth in a single year, but by 2012 you would be back in the green. And if you owned this type of investment in 2020, you would've lost 34% of your money in the single month of March! But by July of that same year, you would've recouped every dollar that you lost.
If you'd sold out of your investments in March 2020 thinking that the crash would go on for longer, you would've missed out on a quick recovery and your rate of return for the year could've suffered as a result. This is why time in the market is so important. And while selling your holdings so that you can avoid a period of losses may seem like a good idea, it could end up costing you.
Reassess your risk tolerances
If you're finding yourself overly worried about a stock market crash, it could be that the way your assets are allocated isn't aligned with your goals. The more stock exposure you have the higher the average rate of return that you receive may be. But this comes with more volatility and you'll have bigger wins in years of good stock market performance and bigger losses in years where the stock market has a negative return.
If you owned 100% stock between 1926 and 2020, you would've experienced an average rate of return of 10.3%. Your best year would've earned you 54% and in your worst year, you would've lost 43%. If these swings are too much for you in the bad years, you could jump ship so that you can stop losses, but a better strategy may be lowering your stock exposure. If instead you owned 60% stocks and 40% bonds, your average rate of return over this time period would've been reduced to 9.1%, but your worst year of losses would've only been 27% and your best year 37%.
You can find out how much risk you feel comfortable with by taking a simple quiz. And answering questions about your time horizon and how you've felt about volatility in the past can give you great insight into how you should best allocate your holdings in the present.
Think long term
What is the money that you've invested for? Is it for retirement in 20 years or for sending your child to college in 5 years? Money that you need in the near term should not be invested aggressively. As you've learned if you lose it, it may take years for you to regain it and it could derail reaching your goal.
If however, you won't need your money for many years, you'll not only have time to recoup your losses but grow your wealth considerably. The S&P 500 opened up on Jan. 3, 2000 trading at 1,469 and it is currently trading at 4,220 -- almost three times as much as the beginning of the decade! And if you invested $10,000 at the beginning of 2000, you would have $29,000 today.
Understand how you're invested
Some stocks trade more volatilely than others. And in a year like 2008, your large company stocks would've lost 37% but an investment in emerging market stocks would've been down by 53%.
If your stock exposure was skewed in this direction, you may have lost more than the indexes that you compared your rate of return to. Understanding your holdings won't prevent you from losing money, but it could help you better comprehend the risks that you're taking. And knowing this could help you set your expectations properly, which could help you stay invested during a period of losses.
A stock market crash is a part of a normal market cycle. And how well you get through one could play a huge role in how much wealth you can accumulate over your lifetime as an investor. And because it's something that is bound to happen, you shouldn't fear it. Instead, learning how you can manage your emotions, educate yourself, and limit your losses is a better strategy for enduring this inevitable occurrence.