Bear markets aren’t always financially crippling! Economic downturns are inevitable, and this crisis tests investors’ financial discipline. What differentiates panic sellers from long-term investors is their ‘smart’ tactics to take advantage of a bear market.
Investors dread bear markets, and you might still recall how the great recession and the financial crisis of 2008 wiped off investment portfolios by as much as 30%. Investors saw their IRAs and 401(k) plans in poor shape, and many sold off their assets at low prices, thereby incurring losses. Just a small group of methodical investors managed to capitalize on the stock market collapse.
Even the pandemic of 2020 saw a 30% downturn in the stock market. However, it took just six months for the market to bounce back. Did you think of taking advantage of bottom fishing when quality stocks were available at cheaper values? Well, taking advantage of a stock market collapse calls for calculated risks. Those who did invest when the market collapsed went on to ride the rebound!
In this article, we’ll explore why investors should tactically infuse more funds into their portfolios when bears take over the market.
Why do investors lose money in a stock market crash?
Before unleashing the best strategies to invest in a collapsing economy, let’s find out why investors end up losing money in a bear market.
As per behavioral finance, most investors tend to be loss-averse rather than risk-averse. The emotional pain of incurring a loss tends to be much more intense than the pleasure they enjoy when they gain a profit of a similar size. Besides, this loss-averting nature prompts investors to sell winning stocks prematurely.
As evident from historic stock market crashes, investors are often overcome by panic. They tend to overreact, selling off stocks that could have fetched them profit had they waited for a rebound. So, rather than blaming the bear market, it’s more of financial indiscipline that investors end up losing money when the stock market crashes.
A historical record of stock market crashes and rebounds
With speculations over yet another recession in 2023, how firmly are you poised to take advantage of the bear market?
The recent bear run in the first half of 2022 should be fresh in your memories. After hitting $4,796.56 on 3rd January 2022, the S&P 500 closed 23% down on 17th June at $3,674.84. Several factors, like rising inflation, geopolitical tensions, supply chain constraints, and rising interest rates, contributed to this bear run.
However, if you observe the historical records, stock markets inevitably rebound after each crisis. As long as you don’t give in to panic and remain strategic with your investments, stock market crashes shouldn’t dampen your spirit.
Here’s a record of share market rebounds after hitting bottom in the last hundred years.
1. The Great Depression (1929)
1929 marked the beginning of the Great Depression. By the time the stock market bottomed out three years later, most stocks were below 80% of their respective peak prices. It took more than 20 years for the market to recover.
2. Black Monday (1987)
The Black Monday of 1897 witnessed a 25% plunge in the stock market. Panic among the investors, market decline, and chaotic trading during early computerization led to the crash. This time, it took just two years for the market to recover.
3. Dot-Com Bubble Burst (2000)
The beginning of the millennium witnessed yet another stock market crash, known as the Dot-Com Bubble burst. All through the 1990s, speculations about investing in internet-related ventures were on the rise. In March 2000, these speculations gave way, and the S&P 500 plunged as much as 50%. The market recovered in the next seven years.
4. The Great Recession (2008)
Just as the S&P 500 recovered from the 2000 crisis, another bear run awaited the economy. The Great Recession of 2008 wiped off more than 30% of the investors’ portfolio, only to recover in the next couple of years.
5. The Covid 19 pandemic (2020)
Worldwide lockdowns amidst the Covid 19 pandemic in 2020 sparked another market downturn. Stocks tumbled more than 30% in a month. As optimists made the most of this crisis, the market rebounded in just six months.
How to take advantage of a stock market crash?
Most investors end up panic-stricken during the harsh bear runs. However, being methodical with your investments and logically channeling your funds can see your assets grow!
How about purchasing stocks at a low price when investors throw them out of their portfolios? Remember, investing in quality stocks will deliver returns when the market bounces back. Rather than entertaining the fear of losing money, it’s wise to go for bottom-fishing stocks that are well below their intrinsic or fundamental values.
As the market rebounds, it rewards patient investors, who can yield profit by investing during the bear run. All you need is financial knowledge, patience, and, most importantly, discipline in handling money. Of course, investors need liquid assets at their disposal to make the most of these opportunities.
Therefore, nothing beats optimism and discipline when you invest in the share market! Here are some guidelines which should help you identify the right strategy to bank on bear runs.
1. Avoid panic selling by staying calm
Before investing in shares, convince your mind that the market is volatile and downturns are inevitable. Avoid panic selling when the market tumbles.
Experiencing a financial plunge can quickly get on your nerves. Refrain from selling off your investments; it won’t do any good. Rather, it can wipe out a significant chunk of your portfolio. Rather, holding on to your current stocks without doing anything can save you from the loss. Don’t make impulse decisions, given that historical records reveal that patient investors have reaped the benefits of a down market over the decades.
Learn to control your emotions and be patient till the market reaches the bottom. The best you can do is to buy in dips.
2. Invest for the long term
Bottom fishing happens to be one of the most lucrative techniques that can fetch you quality stocks at low prices. Once you study the fundamentals of quality stocks, prepare your mind to invest for the long term.
Long-term investments in the share market turn out to be profitable. During this span, the economy might undergo several recessions or crises. This volatility shouldn’t bother you, given that you are concerned with the stock value after five or ten years. This ensures that you just need to channel your funds into quality stocks and wait for their value to grow!
3. Average out by buying in dips
Long bear runs present an excellent opportunity for investors to buy stocks in dips. If you already have quality stocks in your portfolio, why not average them out by adding more at a lower value?
Market dips bring you a lucrative buying opportunity. The strategy involves having adequate funds at your disposal to prepare for the fall. Periodically invest in these quality stocks, and the prices would average out as the value fluctuates over the months.
So, even if you initially purchased a stock at a higher price, an economic downturn can help you lower the purchase price. Selling off the stock when the market rebounds after the crisis would eventually give you a handsome profit.
Even if you don’t succeed in catching the stock price when it’s at the bottom, the average would eventually be lower than the existing value.
However, before you buy stocks in dips, make sure to allocate adequate funds for your retirement. Also, put aside your emergency fund and the cash you need to manage your daily expenses.
4. Diversify your portfolio
Regardless of the type of investment portfolio, diversification of your assets mitigates risk significantly. As quality stocks take time to weather the economic crisis, explore different sectors, asset classes, and markets. In case you realize that your portfolio is at risk due to over-exposure to a particular sector, consider investing in other sectors. This way, you can draw the line of defense against excessive losses. Well, stock diversification doesn’t mitigate the entire risk, but it does reduce your risk portfolio.
Diversification also involves investing in bonds. In a nutshell, distribute your assets across different sectors and investment avenues. When your assets remain concentrated in a single sector, you might end up losing it all if the particular industry tumbles. On the other hand, you would gain marginally from other sectors through a perfectly diversified portfolio. This will help you absorb the financial shock.
5. Buy index funds
If you aren’t ready to choose different sectors and diversify your stock portfolio, why not buy index funds during an economic downturn? Index funds offer exposure to investors to a wide range of companies. Besides, you need not worry about choosing sectors that are likely to profit from the crisis.
Index funds track broad indexes such as the S&P 500. Therefore, a single investment can give you exposure to several sectors and stocks. When the stock market crashes, the value of index funds automatically reduces. Once you purchase these funds at a lower price, you can capitalize on the volatility.
Strategic investors even buy index funds in dips to average out at a lower value during long bear runs. This is an excellent strategy to diversify your portfolio and enter the market at a lower price.
Have adequate savings for the five years before you invest
While bear runs present great investment avenues for long-term investors, they happen to be a trap for short-term investors. Try and resist the temptation to invest amidst the crisis if you aren’t prepared to channel the funds and forget them for at least five years. At times, financial emergencies can be pressing enough to prompt you to liquidate the stocks. In these cases, investors end up losing money when the stock value further drops after they invest.
Never channel all your assets in a single basket during a dry economic run. Also, avoid taking loans to invest in bear runs. This is a dangerous practice, as you never know when the market will rebound. Rather than yielding any return, these investments can land you in debt!
Once you have adequate emergency funds and have saved enough for the next five years, think of investing during economic downturns. Invest the amount that appears to be of no immediate value to you in the stock market!
Endnote
An average investor finds stock market crashes stressful and scary. Only by cultivating financial discipline and remaining calm can you strategize a profitable investment tactic. Volatile markets present opportunities that you won’t get during bull runs!
Investing during an economic crisis also requires adequate research to find quality stocks. Take care not to take leverage, and only channel funds you are ready to block for a long time. Besides, experts advise investing in dividend-yielding stocks to ride the growth besides benefitting from these payouts.
FAQs
1. What is a stock market crash?
A stock market crash refers to an unexpected or sudden drop in the prices of the stock in a broad set of markets. Investors often end up with a loss when they sell off their holdings amidst panic during these crashes.
2. Will you lose all your investments in case the stock market crashes?
No, you won’t lose all your money when the stock market crashes. You simply need to hold on to your investments and wait for the crisis to give way to a bull run. You will lose money during a stock market crash only when you sell off your holdings while the prices remain low. If you are patient enough to let the market recover, you won’t incur losses during the crash.
3. What triggers a stock market crash?
Several factors can trigger stock market crashes. Some of these include new economic policies in governments, political disturbances, and natural calamities.
4. What happens during a stock market crash?
As the prices of stocks across most segments and industries drop during a stock market crash, investors experience a prolonged bear run. Investors often get carried away by herd behavior and sell their stocks out of panic.
5. When did the last stock market crash take place?
The last stock market crash was triggered by the pandemic in 2020. It wiped off 30% of the investments in the stock market in just one month. The crisis lasted for a while, and the market rebounded in the next six months.
