The Dow Jones Industrial Average was recently down almost 12% from its 52-week high, while the NASDAQ Composite was down an even heftier 22%.
Your own portfolio may have experienced a similar -- if not more pronounced -- drop in value over the past few months, and it might have you fretting. Here are three reasons why you shouldn't worry too much about big stock market drops.
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1. Historically, U.S. stock market crashes have been followed by full recoveries
For starters, crashes and corrections are simply a part of life if you're going to be a long-term investor. They happen regularly -- on average, every few years -- but even so, there are few ways to build wealth as effectively as investing in stocks.
That alone might not be too reassuring, but after every previous decline, the market has recovered and gone on to hit new highs. The Dow, for example, was trading around 11,500 at the start of 2000, and it has tripled since then, now approaching 35,000.
Notably, the past 20-plus years included the bursting of the dot-com bubble, the 2008 financial crisis, the 2020 pandemic crash, and other periods of extreme volatility. In the fallout from the financial crisis, the Dow plunged about 30% from its pre-crisis high to its lowest point, while the early stages of the pandemic saw the Dow sink about 35% from peak to trough. As gut-wrenching as those sell-offs were, the market recovered and resumed growing.
2. You won't lose if you don't sell
The next reason to not worry too much about stock market crashes and corrections is this: You don't technically lose any money if you don't sell your stocks. Consider the current downturn for Netflix. The stock recently traded for around $375 per share, down a whopping 47% from its 52-week high of $701. Imagine that you bought your shares around $500 and are now dismayed that you're down 25%. If you sell now, you will indeed suffer a loss of 25%.
But are you only selling out of fear? Do you still believe Netflix has a strong future due to its dominance in video streaming and its proven ability to deliver compelling content? Has anything about your view of Netflix's actual business changed since the shares started falling? Do you think the shares are overvalued? If not, consider hanging on. Netflix has fallen sharply before and then, like the overall stock market, rebounded and gone on to hit new highs.
Keep in mind, however, that some stocks should be sold. Having a clear understanding of the parameters for when to cash out is valuable for investors.
So before a stock market crash causes you to panic, remember the losses for stocks you haven't sold yet are called "paper losses" for a reason -- you haven't actually lost anything yet.
3. Crashes and corrections bring opportunities
Meanwhile, stock market crashes can have some upside too in the form of attractive buying opportunities. There are many, many well-regarded stocks trading much lower than where they were just a few months ago.
Crashes are often great times to go shopping. And be careful not to spend too much time waiting for the market to reach its bottom -- that point will only be clear in retrospect. Instead, if there's a wonderful stock (or several) that looks attractively priced to you right now, consider buying it.
There are different strategies you can employ in this situation. You might simply spend all you want to spend on a certain stock all at once. Or you might split up your purchases to reduce your exposure to short-term volatility. Here's what I suggest: If you really want the stock in your portfolio, and you believe it's attractively priced now, then just buy it. It might drop further, but if its prospects are rosy, it should recover and grow with time.
Investors who have some cash in reserve can position themselves well when a market crash delivers bargains.
When you should worry about stock market crashes ...
Of course, there are times when you should worry about crashes. For example, if you have money in the market that you'll need to spend near term, having it in stocks means you run the risk they may be down sharply just when you need to sell. Avoid this predicament by having an emergency fund at the ready to cover at least several months of living expenses.
Also, if you hold a portfolio of stocks in companies you don't really understand, that's another dangerous situation, as you may not appreciate how far they may fall, or how likely they are to recover.
But overall, for savvy investors, stock market crashes should not be disasters. Indeed, they can be great opportunities.
