Market crashes are inevitable. They may not be predictable, but the fact is that the market will most likely crash at some point while you own stocks. The temptation to sell as soon as the market starts to trend downwards is huge. Many people will rid themselves of stocks at a loss, in the hope of avoiding a worse loss later.
Seeing any kind of a loss in the value of your investment can induce panic. This is called an “unrealized” loss and is a normal part of investing and there are many reasons not to sell during a downturn. Even when you have a large unrealized loss. The biggest one is that people who hold their stocks through a crash often experience a profit in the long term. Unless you are trying to make money quickly (and sometimes even then), selling during a downturn is a guaranteed loss.
Instead, you should keep your time horizon in mind. Many investors are saving for retirement. The reality these days is that retirement can last a few decades and chances are you will make money by holding. Financial writer Ben Carlson invented an imaginary awful investor, Bob, who made his first investment right before a huge crash in 1973, then again before the crashes in 1987, 2000, and 2007. After a lifetime of bad luck, Bob still decided to hold on to his investments without ever selling until he retired when he ended up with a 9% annualized return.
Rather than selling your stocks during a crash, many advisors would actually argue for buying more. Taking advantage of a dip can increase your wealth in the long term since you’re essentially buying stocks at a discounted price. Market crashes are often followed by upturns.
So, what should you do to make sure that you aren’t forced to sell during a downturn? Ideally, you should have enough in your emergency fund so you don’t need to rely on your investments for necessary spending. Try to target an amount that would cover at least three months of spending, with six months or a year being even better.
It’s easy to let emotions overrule reason, so staying calm, sticking to your plan, and not panicking are vital to weathering a downturn. Historically, bear markets have lasted an average of 1.4 years and afterwards, your long term investments typically recover in time. No matter how severe a crash is, don’t let panic overwhelm you and cause you to sell your investments. If you need more advice on how to weather a downturn and develop a long term investing strategy to meet your goals, contact Sharkey, Howes & Javer today.