Stock Market Goes Down: How To Prepare and Not Panic (+ tips)
When the stock market crashes, so can your stomach right down to your shoes. Seeing all that money disappear at once can be frightening to anyone, no matter how stoic or optimistic you are. It isn’t easy to know what to do when stocks are down.
It might be cliche, but as the saying goes, “What goes up must come down.”
However, when your stocks dip, it isn’t the time to panic and drop out. For anyone who has invested in the stock market, drops aren’t ideal. However, you have to know that stocks going down is to be expected since they can’t always go up.
If you are worried about your stocks and their value as you watch the stock market crash, here is our advice for what to do when stocks go down.
Why do stocks go down?
First, let’s start by outlining why stocks go down in the first place. Stock market prices go up and down every day because of market forces. The share prices end up changing due to supply and demand. When the company is doing well, more people want to buy the stock instead of selling it. If the company starts to do worse, then more people stock selling it, and the price falls.
In the end, the stock market might be driven by various factors, but the demand for them majorly determines the prices of stock at any moment. So, for example, if something bad happens to the company that seems to put it in a worse financial situation, people won’t want to buy stock, so the price will go down and down until people are comfortable trading it back and forth again.
What should you do with your portfolio if stocks go down?
Of course, if you had your choice, your stocks would always be in demand. However, that isn’t always how it works. If your stocks start to take a hit, here’s what you should do.
Don’t panic
Don’t panic and sell everything! Instead, take a couple of deep breaths and relax. Although it doesn’t always work out for the better, more often than not, the best thing to do is to hold out. You read that right. Don’t do anything. Most importantly, don’t panic sell. Instead, hold onto the stocks and re-evaluate the situation.
Think about the companies you have invested in and whether the companies still suit your investment priorities. Are the companies you put your money into still one’s that suit your portfolio criteria? If they are, hold out and wait for the light at the end of the tunnel. If not, then take a couple more deep breaths before taking the next step.
It is also beneficial to keep in mind that investing with a long-term mindset can help you make much more money in the long run.
Here’s an interesting image for you:
This chart shows what happens if you pull your money out and end up missing the best 5 or 10 days the company stocks experience. The only way to make sure you hit the best 5 days in a 10 year period is to stay invested the entire time.
Make sure you’re diversified
The next step you should be considering is diversification. Diversifying your portfolio is the best way to keep you and your money safe.
Diversification involves holding a wider variety of investments in all kinds of industries, not just a variety of companies. That means you might invest in IT companies, hold some international stock, index funds or some bond funds, or invest in real estate investment trusts. There are so many places and areas in which you can put your money. The more you spread the wealth, the less you will lose if one of the industries or companies crashes for a time.
The truth is that picking your asset allocation is more important than making any individual stock choice will ever be. However, even if you have bought all kinds of different stocks, you still have only invested in stocks and aren’t truly diversified. If you are interested in taking this step and learning more about diversifying your portfolio, check out this article.
Consider buying in the dip
The other side of a dip in the market is the opportunity it gives you to take advantage of certain stocks and buy them up. This is how to make money when stocks go down. Market dips are often when fortunes are made. However, they can be tricky since you need to be ready for their fall and then be willing to sacrifice that money if all they do is keep falling.
The best way to be ready to buy in a dip is to be specific about it and save for it. Our suggestion is to keep a running list of the individual stocks you would someday like to own. Call this your “stock wish list.” Although it might not be something you will send off to the North Pole, you can make your own wishes come true. Keep an eye on the companies to watch for moments when they dip.
It is also essential to make sure that you only use money that you have set aside for investing. If you see what you think is an opportunity during a market dip and decide to invest your emergency funds, you are putting a lot more at risk than just getting unlucky on one stock selection. Likewise, you should never invest money that you think you will have to use in the next few years. Sometimes it might pay off for people, but the risk of finding yourself penniless in the future is never worth it.
We typically recommend for people to invest most of their money into 401ks, index funds, and Roth IRAs. Then, if you want to take 5-10% of your investment money and put it into individual stocks, it will only be a small percentage of your portfolio if you lose it.
Don’t try to time the market
When you are a long-term investor, you need to manage your stocks so that you will be able to maintain them for years to come. If you are constantly checking in to try to spot a low period for certain stocks so that you can buy them up, you will end up going crazy. A watched pot never boils and all that.
Instead, regular investing over time will end up yielding you more solid returns. It is rarely a good idea to try to go into something to make quick money. Being smart about it and patient is the best combination to make the most money in the long term. Don’t feel pressured to buy in a low. Just take advantage of it when it becomes available.
Stay calm and remember the long haul
Although it is difficult for us to think long-term, it is necessary if you want to invest successfully. Some people might invest for the short-term, but unless done well, this doesn’t always end well. Think long-term and invest for the long term. Over years of investments, a dip now will not matter. Low points are all part of the process.
Consider Apple as a good example of this. Those that have invested long-term have seen huge returns come back from it. From 1995 to 1998, the company saw some hard-hitting dips, at one point experiencing a whopping loss of about 41%. Since then, they have closed at $188 and have split twice since that terrible low point from 1998. Long-term investors in the company have seen their stocks rise dramatically over the last 20 years but will have been extremely disappointed all those years ago.
The name of the game is… risk tolerance. You have to ask yourself how much risk you are willing to take and invest accordingly.
FAQs About What To Do When Stock Market Goes Down
Do you lose all the money if the stock market goes down?
No, a stock market crash occurs when the price of stocks drops dramatically but does not entirely wipe out all of a person’s investments. The money is lost only if he/she sells their stocks during or after the crash. The stock market’s volatility means that prices will rise again soon after a fall. Patience is important for investors in such situations.
What causes the Stock Market to go down?
Several factors contributed to the stock market crash, including economic changes, geopolitical issues, and external economic events.
Can you make money when the Stock Market goes down?
Investors can also profit from a bear market by short-selling stocks or shorting equity index futures. In this strategy, an investor borrows shares that they do not already own and sells them in the expectation of repurchasing them at a lower price.
Just breathe
When you are ready to panic, pack up, and leave, take a deep breath, and realize that a dip in stocks is all part of the process. If you haven’t diversified already, you need to get on it to spread the wealth and lower the overall risk. You should consider buying when there is a dip but don’t go crazy looking for one. And remember, you should be investing for the long term.
If this still seems overwhelming for you, check out this article on investing for beginners to better wrap your mind around the stock market. If you want more guidance on what to do when stocks go down and any other money management issues you currently have, check out our free resource below, The Ultimate Guide to Personal Finance, to make your money start doing what you want it to do.
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16 Comments
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Kimber
I prefer stocks that have both capital gains and income going for them. Sure the stock prices still fall (ouch) but at least I feel I get paid while I wait for the correction. I find a down market is a great way to measure the value of a company. A good solid company will decrease less than the index and correct faster. Plus of course, it's time to go shopping!
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Matt
Totally off topic, but ramit, what are your thoughts on making money off Prosper(www dot prosper dot com), It's a pretty interesting concept, but it's pretty long term. Also there's a risk if the person defaults but, if you spread it out...less risk. What do you think?
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Jeff O'Hara
My opinion is the amateur investor really has no business playing the stock market game. I played and I lost. It's basically gambling if you don't keep up with the companies your investing in. Every amateur investor should invest in index funds, they do what the market is doing and historically have done well. We aren't talking crazy returns, but good returns that will beat any money market or cd. Another reason is most amateur investors don't have enough money to play the stock market to diversify well. Index funds are are already diversified. I put money in Small Cap, Mid Cap, and Large cap with the bulk being in small cap (50%), then the rest is split between mid(35%) and large caps(15%). As I get older, I will change and put more into large and mid and less into small, as small caps can be the most volatile, but also have the biggest gain. That is my plan for the amateur stock investor, you can agree with this or not, but this has been working quite well for me since i got burned playing the individual stocks game. -Jeff O'Hara http://blog.zemote.com
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Thomas
Brilliant post – I especially appreciate the part about the "best ten days"; far too many tend to only focus on the risk one is exposed to while being in the stock market, while not realising the risk of not being in the market when stocks are up. Thinking in terms of "dual risks" can be very useful!
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Roman
I don't suppose you could dig up statistics on the cost of being out of the market on the worst 5/10/etc days?
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Investorial
I think this post brings up the fact that most people worry much more about their selling decision -- should I sell to cut my losses? or will it ever bounce back? I firmly believe that the buying decision is the more important of the two. Too many purchases by beginner investors are based on impulse, fleet of the moment. You also made a good point about staying in the market but a better question is why people are buying and selling so often in the first place? What's driving them not to stay in the market? Playing devil's advocate, yes, I'd like to also see the statistics on being out the 5 / 10 / etc WORST days as well. Bringing up those favourable statistics only serve to build your thesis. It's like only surveying Chinese people if they like eating rice and noodles. My point is that stock investors can also be market timers too. Time your entry point.. your buy decision! What do you base your buying decision on? Most poker pros say that beginners get into trouble because they're playing too many hands... they end up chasing cards and blaming it on not catching the river, but the flawed decision was playing with marginal hole cards... looking for marginal chances of victory. Sound familiar?
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Ramit Sethi
Roman and Investorial, you can see the best and worst days from the link I posted in the article.
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Jason Yip
I'm with Doug Brown on this one. It's just a buying opportunity but I also tend to dollar cost average on managed/mutual funds and I have a significant investment horizon. Up, down, who cares? If it's up, I buy less; if it's down, I buy more.
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RJ
"If a stock drops 8% (or 10%, or 12%), I'm out of there." I've been playing the stock game for over 15 years... There is truth in the above statement. You never know how far a stock will drop (or rise!). Do you really want to be holding Nortel... or Cisco... or Verizon. Or how about Enron, Worldcom, etc... Certaintly all those companies have (or had) what seems like valid business models. When a stock starts to drop, get out! You can always get back in if it starts to turn around. Now, using an example of Nortel... it may recover - eventually. But how long do you want to hold a dead stock? What is the oppurtunity cost of this?
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debt-free
RJ - what is the opportunity cost of spending all your time buying/selling/trading/stewing/fretting/freaking over all of these single stocks? Pick a mutual fund with a good track record (10-20 years) and leave it alone. And stop watching CNBC all day.
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John
You have more studying to do. I've taken huge hits in the past, but not anymore. A skilled investor loses some money sometimes, but never loses a lot. To make the argument you're looking for, you have to say the investor who knows fundamental value ignores the losses because they know the company is undervalued in the market. Fine, but what makes you a fundamental value investor? Because the complexity blows my mind. And I've learned to embrace that ignorance... sensing ignorance and danger is wise! While I study the topic a few hours each day, I can't say I'm an expert. Know what you don't know! You've presented a few curiousities, but not a philosophy. You need to learn the difference between technical and fundamental analysis, and between trading and investing. I'm only holding JNJ, a defensive issue, and have earned quite comfortably in recent weeks. I've also learned to favor fundamentally exceptional stocks, to wait for the right time to buy, and to accept very small gains, rather than chasing a big hit. Even AAPL is beyond my risk profile. I make about three trades per year, and that's probably too many! I earn $11/day on CD's... guaranteed. If I'm switching money from there into a market with risk, there better be a good reason. Vegas is not a good reason. There's a saying in trading: Bulls can make money, and bears can make money, but pigs get slaughtered. Know what you're doing, or stop doing it.
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Hermann Klinke
Ramit, I don't know how much you or others on this page know about investing in stocks, but nobody should invest in stocks unless they really know what they are doing. I started a few months ago really getting into it and there is soooo much to learn and if you really know the stuff, then there is a lot to gain. You can expect returns of up to 100% a year, if you are really good at it and I don't mean timing the market. I mean doing your technical and fundamental analysis and having several trading strategies. I recommend reading investopedia.com for free and/or pay and learn it from spreadtradesystems.com. What I love about stocks is that you can make money in any situtation, whether stocks are going down, up or staying the same.
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ETF Guy
Ramit, I'm sure you've heard this before, but unless you have a lot of time to research companies, you're better off in a traditional fund or exchange traded fund. A vast majority of the pros who spend their days doing analysis fail to beat the "market". And the fund managers that everyone hails as being above the rest still only achieve low double-digit returns. I feel bad for Hermann who thinks that with enough work he can expect 100% returns. That just isn't going to happen. But good luck with whatever path you choose!
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Josh Love
I have lost money as well on very good companies. Recently, Whole Foods Market and Yahoo have been killed in the market for "minor offenses" in terms of bad performances. However, i think if you really believe in the company, stick with it. You will be rewarded down the road.
Comments are closed.
Doug Brown
Personally I see stocks going down as a chance to buy more at a cheaper price. I would certainly not sell at a low price. But hey, I am one of those old fashioned buy low, sell high people. Of course there is the assumption in there that the price will rise again to its previous (faster than inflation).