Everywhere you look for financial advice, you'll hear people advising to invest your money in the stock market. Stocks are riskier than some assets, like bonds, but have enormous potential for growth, so long as you diversify your portfolio.
That said, there's always the possibility of a stock market crash--a period of time where stock prices plummet. Many new investors are afraid of this possibility, partly because market prognosticators have been peddling the potential for the next bear market. In light of the market hawks, it is easy to understand how retail investors may have trepidation about investment decisions.
For example, millennials are especially skittish about investing in stocks because they came of age in or around the economic collapse of 2008. If you're finally in a financial position to be able to invest in stocks, you might be concerned about the looming threat of a trade war pushing stock prices lower--especially after the tumultuous back half of 2018.
In any case, being scared of a stock market crash isn't necessarily a good reason to avoid investing altogether. It just means you need to come up with an alternative strategy.
Setting Clear Expectations
First, we need to set clear expectations for how stock market crashes work, and whether you really need to be afraid of them. The standard definition for a stock "crash" is any day when the S&P 500 or Dow Jones Industrial index falls by more than 10 percent. Some crashes have led to total price drops of 40 percent or more. Since the 1920s, there have been four major stock market crashes: in 1929, in 1987, in 1999 and 2000 (thanks to the dotcom bubble), and in 2008. Undoubtedly, losing 40 percent of your investment would be considered a significant loss.
However, regardless of whether these crashes led to a recession or a full-scale depression, they have always been followed by a period of recovery. For example, if you had invested $1,500 across the S&P 500 in January 2008, it would have fallen to less than $800 by March of 2009.
But by April 2013, it would be up to $1,600, and today, it would be nearly $2,700. Even assuming the worst-case scenario, stock market crashes are more of a temporary inconvenience than an investment-ending catastrophe. On top of that, stock market crashes are rare, and if you put money in regularly, it's impossible to be wholly exposed to a worst-case scenario like this, since you'll buy in at many different price levels; imagine investing at the bottom, and tripling your money in less than a decade.
Putting stock market crashes in perspective helps you be less afraid of them. That doesn't mean you can safely ignore them, but you can avoid letting them dictate your entire strategy.
Investing for the Long-Term
Much of the impact of a stock market crash can be mitigated by investing for the long-term. In the context of an entire decade, stock market crashes are but a blip on the radar.
Investing for the long-term means buying and holding for years, if not decades--not selling your stocks at the first sign of trouble. Your losses and gains only truly exist once you "realize" them by selling. It also means diversifying your portfolio with stocks from different industries and of varying sizes, so you're never exposed to too much risk. You'll also need to put money in gradually--ideally a few times a year--so you don't find yourself in the position of buying at the top and suffering the worst elements of the crash.
Preparing for a Crash
That said, if you seriously suspect a market crash is on the horizon, or you're nearing retirement and need to guard yourself against one, there are some strategies you can use to mitigate your risks even further:
- Steady market sectors. Invest in steady market sectors, like utilities, which are historically less affected by crashes than other sectors. Tech and luxury goods stocks tend to suffer disproportionately in poor market conditions.
- Bonds. Bonds don't see the same level of growth as stocks, but they're extremely stable investments. They should occupy a greater percentage of your portfolio as you get older, and as you attempt to reduce your total exposure to risk.
- REITs and real estate. Real estate is often a tangible investment, and one that provides a different type of return than the stock market; you can collect rent in addition to seeing growth on your property values. If you don't want to buy real property, you could invest in real estate investment trusts (REITs).
- Precious metals. Precious metals like gold and silver aren't good investments to grow your wealth over time, but they are real assets and their prices remain relatively stable. They tend to experience price growth when the stock market crashes, and therefore, serve as reasonable complementary investments if you're anticipating one.
Even in a volatile market or an uncertain one, investing in the stock market is good for your financial future. Don't let fears of a crash deter you from investing; instead, use it as inspiration to learn more about market fluctuations, and compensate for them with the right strategies.