Stock Market Down? One Thing Never to Do

Don’t panic. Have a strategy in place.

Reviewed by Samantha SilbersteinFact checked by Kirsten Rohrs SchmittReviewed by Samantha SilbersteinFact checked by Kirsten Rohrs Schmitt

When the stock market goes down and the value of your portfolio decreases significantly, it’s tempting to ask yourself whether it’s time to bail out of the stock market. That’s understandable, but most likely not the best decision. Instead, you should perhaps be asking, “What should I not do?”

The answer is simple: Don’t panic.

The second question might be, “Should I buy more?” The answer is maybe.

Key Takeaways

• Panic selling can hurt you in the long run.
• Judging your risk tolerance before you buy will help you choose investments that won’t disappoint you in the long run.
• Diversifying your choices among a variety of asset classes can mitigate risk during market crashes.
• Experimenting with stock simulators before investing real money can give you insight into market volatility and your emotional response to it.

Why You Shouldn’t Panic

Panic selling is often people’s gut reaction when stocks are plunging and there’s a drastic drop in the value of their portfolios.

That’s why it’s important to know beforehand your risk tolerance and how price fluctuations—or volatility—will affect you.

You can also mitigate market risk by hedging your portfolio through diversification. That means spreading your money around a variety of investments, including some that have a low degree of correlation with the stock market.

Why Invest in Stocks?

About 39% of Americans do not invest in the stock market, according to an April 2023 Gallup survey. Gallup concludes that the reason is a lack of confidence in the market, particularly after the 2008 financial crisis. Stock market participation dropped significantly in the wake of that crisis. Of course, some respondents don’t have money left over to invest after taking care of necessities.

A stock market decline due to a recession or an event like the COVID-19 pandemic can put core investing tenets, such as risk tolerance and diversification, to the test.

It’s important to remember that the market is cyclical and declines are inevitable. But a downturn is temporary. It’s wiser to think long-term instead of panic selling when stock prices are at their lows.

The Cyclical Effect

Long-term investors know that the market and economy will recover eventually, and investors should be positioned for such a rebound.

During the 2008 financial crisis, the market plummeted, and many investors sold off their holdings. However, the market bottomed in March 2009 and eventually rose to its former levels and well beyond. Panic sellers missed out on the recovery, while long-term investors who remained in the market eventually recovered and fared better over the years.

The S&P 500 plunged by a gut-wrenching 35% in little more than four weeks in March 2020, when the stock market entered a bear market for the first time in 11 years in response to the global pandemic.

The index not only rebounded swiftly from those lows but has hit record highs several times since. In 2022, the stock market dropped again from the highs seen after the pandemic, with the volatility continuing into 2023. In the first half of 2024, it set more record highs.

What You Should Do When the Market Is Down

Instead of locking in your losses by selling at the lows during a steep market correction, formulate a bear market strategy to protect your portfolio at such times.

Here are three steps you can take to avoid any reason to panic when the stock market goes down.

1. Understand Your Risk Tolerance

Most investors probably remember their first experience with a market downturn. It was probably unsettling, to say the least.

That is why it is important to understand your risk tolerance beforehand when you are in the process of setting up your portfolio, not when the market is in the throes of a sell-off.

Your risk tolerance depends on a number of factors such as your investment time horizon, cash requirements, and emotional response to losses.

Many investment websites have free online questionnaires that can give you an idea of your risk tolerance.

Another way to understand your reaction to market losses is by experimenting with a stock market simulator before investing real money. You can invest an amount such as $100,000 of virtual cash and experience the ebbs and flows of the stock market. This will help you assess your tolerance for risk.

Your investing time horizon is an important factor. A retiree or someone nearing retirement is focused on preserving savings and generating income in retirement. That suggests focusing on low-volatility stocks or a portfolio of bonds and other fixed-income instruments. Younger investors might invest for long-term growth because they have many years to make up for any losses due to bear markets.

2. Prepare For and Limit Your Losses

Ultimately, you should be ready for the worst and have a solid strategy in place to hedge against your losses.

Investing exclusively in stocks can cause you to lose a significant amount of money if the market crashes. To hedge against losses, investors strategically make other investments to spread out their exposure and reduce their overall risks.

By reducing risk, you face the risk-return tradeoff. Your potential upside will be reduced.

Downside risk can be hedged by diversifying your portfolio and using alternative investments such as real estate that have a low correlation to equities.

Having a percentage of your portfolio spread among stocks, bonds, cash, and alternative assets is the essence of diversification.

Every investor’s situation is different, and how you divvy up your portfolio depends on your risk tolerance, time horizon, and goals. A well-executed asset allocation strategy will allow you to avoid putting all your eggs in one basket.

Investing in the stock market at predetermined intervals, such as with every paycheck, capitalizes on a strategy called dollar-cost averaging. Your cost of owning an investment is averaged out by purchasing the same dollar amount at periodic intervals, which often lowers the dollar cost of the investment.

3. Focus on the Long Term

Stock market returns can be quite volatile in the short term but they outperform almost every other asset class over the long term. Over a sufficiently lengthy period, even the biggest drops look like blips in a long-term upward trend.

This point needs to be kept in mind during bad times.

Having a long-term focus will also help you perceive a big market drop as an opportunity to add to your highest-quality holdings. Consider it an opportunity to pick up select blue chips at attractive prices.

You might also consider dollar-cost averaging to smooth out the blips. This involves purchasing the same dollar amount of an asset at periodic intervals, such as monthly. Your purchase price per share will fluctuate over time but your average cost per share will probably be lower.

Is It Better to Buy Stocks When They Are Down?

Buying stocks when the overall market is down can be a smart strategy if you buy the right stocks. You could pick up some blue-chip winners that will perform well in the long run.

Weaker stocks that rode the market higher are better avoided.

The same rule applies to selling when the overall market is down. If the stock looks like a long-term loser, it could be wise to bail out while you can. If it’s a long-term winner, bailing out locks in your loss.

Do Bonds Go Up When the Stock Market Crashes?

Bonds usually go up in value when the stock market crashes, but not all the time.

The bonds that do best in a market crash are government bonds such as U.S. Treasuries. Riskier bonds like junk bonds and high-yield credit do not fare as well.

U.S. Treasuries benefit from the flight to quality phenomenon that is apparent during a market crash. Investors flock to the relative safety of investments that are perceived to be invulnerable.

Bonds also outperform stocks in a stock bear market as central banks tend to lower interest rates to stimulate the economy.

Should I Invest in the Stock Market if I Need the Money Within the Next Year to Buy a House?

Emphatically no.

Investing in the stock market works best if you are prepared to stay invested for the long term. Investing in stocks for less than a year may be tempting in a bull market, but markets can be quite volatile over shorter periods.

If you need the money when the markets are down, you risk having to sell your investments at precisely the wrong time.

The Bottom Line

Panic selling when the stock market is going down is more likely to hurt than help your portfolio. Moreover, you’re locking in those losses.

This is why it’s important to understand your risk tolerance, your time horizon, and how the market works during downturns. Experiment with a stock simulator to identify your tolerance for risk and insure against losses with diversification.

You need patience, not panic, to be a successful investor.

This article is not intended to provide investment advice. Investing in any security involves varying degrees of risk, which could lead to a partial or total loss of principal. Readers should seek the advice of a qualified financial professional in order to develop an investment strategy tailored to their particular needs and financial situation.

Read the original article on Investopedia.