How To Invest When the Stock Market Crashes

During a period of economic downturn, it can be challenging and nerve-wracking to decide where to invest. Traditional investments like stocks may pose higher risks when the market is on a downward trend. However, adhering to these fundamental and enduring strategies can help you generate consistent profits, even amidst a recession.

Is the stock market falling?

Recently, the definition of a stock market crash has become clearer. In 2022, investors were worried about a potential crash due to the market's extreme volatility caused by concerns over rising inflation, interest rates, and global geopolitical uncertainty.

Although investors felt relieved in mid-summer, their fears of continued declines resumed by late August. Both the S&P 500 and the Dow experienced over 4% decrease.

On September 13, higher-than-anticipated inflation and concerns about a sudden rate hike caused another decline. In just one day, the Dow dropped over 3.5%, the S&P 500 index decreased over 4%, and the Nasdaq-100 index, which focuses on technology, fell over 5.5%. The market's decline persisted for several more days.

Although historical trends can give us insight into the duration of declines, stock market corrections, and bear markets, no one can predict the timing, nature, or extent of future declines.

What to do when the stock market falls?

Even with diligent preparation, a stock market decline will inevitably impact your investments. While many experts provide guidance on how to prepare for a crash, few offer a comprehensive solution for what to do after it occurs. Not everyone has the financial stability or patience to wait for the stock prices to rebound, leading to significant pressure during such situations.

In such times, it is essential to take a deep breath and relax your body. The next step is to review the following checklist, which can guide you on what to do when the stock market goes down.

Don’t do anything while the market is falling

If you have faith in your investment strategy and the assets in your portfolio, it is advisable to stick to your plans unless you have a good reason to make changes. When you constructed your portfolio, you likely considered the possibility of a market crash.

Those who panic during a crisis often end up regretting their decisions. Consider those who sold their stocks in the spring of 2020, when the S&P 500 Index plummeted over 30% in a brief span of time. They soon regretted their actions as the market rebounded rapidly due to the pandemic's swift growth. By the end of 2020, these individuals had missed out on 65% of the gains since the crash.

Having accumulated enough for the next five years, invest as much as you can

Stock market crashes are always worrisome and unfavorable for short-term traders. This is largely due to the fact that the money involved in the market is often borrowed or leveraged from other assets. It is not recommended for any investor to enter the stock market without having saved enough money for the next five years.

Investors in the stock market must be wise and understand the market's volatility. Blindly investing in stocks can lead to significant losses in the long run. If you choose to invest in stocks, ensure that you have enough reserves for future withdrawals. One strategy is to invest in stocks that generate regular income, even if their value drops in the short term. This approach can help you maintain a steady stream of income, even if the market declines.

Average Dollar Value (DCA)

Continuing to contribute to your 401(k) or individual retirement account (IRA), or investing in a non-retirement account through a broker, may be a wise decision during a recession.

A dollar-cost averaging strategy enables you to invest a consistent dollar amount regardless of market fluctuations. This means that when stock prices are low, you purchase more shares, and when they are high, you purchase fewer shares. The table below illustrates an example of an investor buying $1,000 worth of stock every quarter for a year.

As shown in the table, the investor consistently buys shares each quarter, regardless of stock prices. This results in the investor buying more shares when the prices are low and fewer shares when prices are high. Over time, this strategy can lead to a lower overall cost basis and greater potential returns.

Confidence Diversification

Diversification is an effective strategy to reduce investment risk and navigate turbulent markets. By investing in different asset classes such as stocks and bonds, you can mitigate losses when a specific stock or industry underperforms. The goal is to spread your investments across different baskets, so that a dip in one area can be offset by gains in another.

For those who prefer a hands-off approach, a “set it and forget it” strategy is a good option. This could involve regularly investing in a retirement fund or using a robo-advisor that automatically diversifies your investments. With this approach, you can have confidence in your portfolio's ability to withstand market volatility, while still experiencing short-term fluctuations. By diversifying your investments, you can help ensure that your portfolio remains healthy and resilient over the long term.

I’m looking for dividends while the stock market is falling

For investors who are willing to take a more proactive approach during a market downturn, considering dividends as a factor in investment decisions can be a wise strategy. Similar to how banks pay interest to savings account holders, many companies distribute a portion of their profits to shareholders in the form of dividends.

Although dividends are not guaranteed and can fluctuate, companies that pay dividends are often more established and have less volatile stock prices. As long as the company continues to pay dividends, investors can expect some level of return on their investment. Therefore, investing in dividend-paying stocks can be a smart move during a market downturn when stock prices and returns are uncertain.

Buy more stocks if possible

When the market experiences a downturn, it presents a prime opportunity to invest in more stocks, particularly if you have already accumulated enough and possess other assets that generate income. This is because during a stock market crash, prices for all stocks tend to decline, creating a favorable environment for purchasing stocks at a low price and subsequently selling them at a higher price.

While it is a well-known principle of the stock market to purchase stocks at a low price and sell them at a higher price, one must exercise caution and avoid purchasing stocks indiscriminately. While a stock market crash can encourage investors to buy more stocks, it is essential to exercise patience and conduct comprehensive research on prospective companies. This research should include critical data, such as cost ratios and other statistics that help guide investors in the right direction, as well as estimates of how long it will take companies to increase their stock prices in the aftermath of a stock market crash. Ultimately, this research can help identify companies that have demonstrated excellent performance despite the direct or indirect impact of a stock market crash.

Focus on the long term

When the stock market experiences a decline, it can be challenging to resist the urge to take action when you see your portfolio's value decrease. This can be especially difficult if you're dealing with personal issues such as illness, financial strain, or job loss, particularly during a pandemic like COVID-19. While it's understandable to feel pessimistic after a crash, if you're investing for the long term, it's often best to do nothing at all.

It's essential to remember that selling your investments during a market downturn can result in suppressing losses. For instance, consider the market crash associated with the COVID-19 pandemic in February 2020. Suppose you invested $1,000 in an ETF that tracks the S&P 500 Index. During the spring of 2020, this type of fund lost over 30% of its value. If you sold your investment, you would have lost 30% of your initial investment. However, if you held onto it, you would have recovered the loss by August and experienced growth since then.