What’s your plan if the stock market crashes tomorrow? Bear markets are inevitable, and having a contingency plan for the bad times can completely change the way you live and retire. If you play your cards right, you can manage the risks of a plummeting market. You can even capitalize on the opportunities available when everyone else is panicking and running for the exits.
If you’re in a position to make these four shrewd moves, then you can overcome the pain of a market crash by embracing the opportunities. If you’re not in a position to make these moves right now, start thinking about ways to prepare for stormy days ahead.
1. Remain calm
This one cannot be stressed enough. In the hours and days immediately following a market crash, this effectively translates to “do nothing.” Watching your investment account values plummet can trigger some deeply emotional reactions, but emotion shouldn’t play a significant role in investing. Panic can completely poison an otherwise well-constructed plan. It’s basically impossible to act with robot-like precision, but do your best to set some rational goals and adhere to them.
Avoid selling when the market is down. You’ve probably heard the advice to “buy low and sell high” — and getting rid of your stocks at the bottom of a bear market is the exact opposite of that. Watching your children’s college fund, your retirement plans, or your home down payment go up in flames can be a harrowing experience. Nonetheless, you need to recognize that every market crash has been followed by a bull market as the global economy and its biggest companies continue to march forward in the long term. You only lock in losses when you cash out — staying invested gives you the opportunity to ride out temporary downturns and take advantage of the recovery that inevitably follows.
Keep your eyes open for new opportunities.
2. Take inventory of your other assets
When one asset class is experiencing an extreme event, it’s a great time to check up on other elements of your financial plan. Most people own some combination of real estate, bonds, cash (including foreign currency, digital currency, and CDs), and insurance policies with cash values or annuity accounts. These other assets may be performing in completely different ways compared to your stock portfolio.
Make sure you have enough liquidity to meet your household financial obligations without selling your temporarily depleted stock holdings. If there’s a recession going on, then you should be ready to ride out unexpected expenses or losses of income. Determine what your best sources of liquidity are. If possible, you want to find cash that you can use to purchase stocks that are “on sale” after they plummet.
I’ve seen people who paid down their mortgages ahead of schedule during times when the stock market seemed expensive, then later opened up HELOCs to access their home equity. This allowed them to buy up stocks that were temporarily cheap relative to their fundamentals. After five years, they were able to pay down the HELOC and retain huge excess gains from their investments. I wouldn’t necessarily recommend taking on debt to purchase volatile assets like stocks — that can obviously lead to disastrous consequences. However, that’s the sort of thinking that can separate an average financial plan from an excellent one, as long as it’s executed in a moderate and measured way.
The key here is to know where you stand outside of your investment account and assess the risks and opportunities of your whole financial plan. Think differently from the herd if you want to achieve exceptional outcomes.
3. Rebalance and reallocate
After a market crash, the likelihood that stocks will move drastically lower is reduced, and the amount that they can decline should also shrink. Over the long term, stock valuations always come closer to reflecting the profits and dividends produced by the underlying business. In a bear market, shareholders can gain exposure to those profits and dividends at better prices.
Once a crash occurs, the balance of risk shifts. The downside potential is limited, while opportunity cost rises. Opportunity cost is the loss you incur by failing to achieve appreciation with an investment — the more growth you could hypothetically achieve, the higher the opportunity cost. You shouldn’t drastically alter your allocation in this situation, but you might want to consider some riskier growth stocks that might’ve looked too pricey before.
4. Harvest tax losses if applicable
This doesn’t apply to everyone, but tax-loss harvesting is an important part of improving net returns for many people. Tax-loss harvesting involves reducing taxable gains by selling holdings that have negative returns, then replacing them with similar holdings that will grow in the future. For example, you could sell an index-tracking ETF at a loss, then use those proceeds to purchase another fund that tracks the exact same index. That creates a loss for the current tax year that you can use to reduce your net gains, thereby limiting the check that you owe to the IRS without changing your growth outlook.
That obviously reduces your cost basis for taxation on future gains, and trading will incur some additional expenses above the cost of simply holding the initial investment. Make sure that you’ll actually benefit from harvesting those tax losses before you go ahead and complicate the situation.