Six Strategies to Help You Navigate Stock Market Crashes

When the stock market rises, it also raises the spirits of many investors. After all, who wouldn’t want to see their investments grow? However, there also comes a time when the stock market crashes, causing panic in the very same investors.

However, market crashes are usually part and parcel of the economic cycle. While they may lead to stress and panic, market crashes can also present potential investment opportunities if used wisely.

In this article, we will learn six practical ways to prepare for a stock market crash and potentially mitigate its impact.

• Table of contents

• Six things you should do in a market crash

Six things you should do in a market crash

It’s quite natural to feel anxious when the stock market falls. However, by following certain guidelines, you can seek to navigate market turbulence calmly.

Here are the six approaches:

1. Avoid the urge to sell in panic

The first mistake many investors commit during a stock market crash is to immediately sell everything. Though it is tough not to react when you see the market dip, try to hold off your decision to sell.

Markets typically recover after a crash and can potentially grow over time (past performance may or may not be sustained in future). By exiting at the first sign of trouble, you miss out on potential gains if the market eventually bounces back. So, instead of selling your investments and locking in losses, stay calm and let your Systematic Investment Plans (SIPs) leverage these market dips.

2. Avoid the urge to buy anything

Just as selling in panic is risky, rushing to buy stocks simply because they are cheaper can also be risky, especially for those who do not have the required expertise. Not every stock whose price drops is a suitable purchase. Some may not recover from a major downturn.

However, if you can seek financial advice or do thorough research, a market dip can be a potential opportunity to buy stocks with strong fundamentals and long-term growth potential at lower rates. Look at businesses that have low debt, consistent profits, and a track record of overcoming economic slowdowns (past performance may or may not be sustained in future). Avoid speculative investments or risky bets.

Read Also: Impact of Behavioural Finance on Market Conditions

3. Rebalance your portfolio

Rebalancing your portfolio can help you navigate market downturns. Rebalancing means adjusting your investments to maintain your desired asset allocation. If stocks have fallen sharply, your portfolio might be more weighted toward relatively stable assets like bonds or cash. By rebalancing, you can maintain your target equity-debt ratio, aligning with your goals and risk level.

For example, if your original plan was to have 70% in stocks and 30% in bonds, a market crash might shift the value of your portfolio to 50% stemming from stocks and 50% from bonds. Rebalancing would involve selling some bonds and buying stocks to get back to 70/30. If markets recover, those stocks, now purchased at lower prices, can potentially offer growth.

4. Take advantage of tax laws

While it’s recommended to avoid panic-selling during a market crash, there’s also a strategic way to potentially leverage a downturn – through a strategy called tax-loss harvesting.

Tax-loss harvesting involves strategically selling specific mutual funds or stocks that are unlikely to recover. The realised losses can then be used to offset capital gains from other profitable investments, thereby reducing your tax burden and improving overall post-tax returns.

If done strategically, it can allow you to exit underperforming holdings and reallocate funds to investments with more long-term potential.

Many people use this at the end of the financial year, but you don’t have to wait. If you plan carefully, you can use it during a crash too, as long as it fits your long-term goals. It is also recommended that you take the help of a financial advisor for this.

Read Also: Bear Market: Meaning, Types, Examples and Causes of Bear Market

5. Keep your personal finances intact

Market crashes can potentially erode significant value from your investment, but you should always prioritise your personal finances. Here’s how you can do it:

• Tracking money flow

Keeping a personal cash flow statement means writing down all the money you earn and spend each day. This helps you stay organised and ensures you can still cover important costs like rent, utility bills and school fees, even if the stock market crashes.

• Build an emergency fund

An emergency fund can act as a financial safety net. If you don’t have one yet, start building it now. If you already have an emergency fund, a market crash is a good reminder to add more to it. Generally, it is advised that an emergency fund should be large enough to cover 4–6 months’ worth of expenses, though the amount can vary depending on individual circumstances and expenses.

• Be careful with debt

When markets crash and times are uncertain, it is generally advisable to avoid taking on more debt, as doing so could add pressure to your financial situation. Instead, it may be more prudent to focus on managing your current debts. If you have a strong credit score and have been paying your EMIs on time, a market downturn could also be an opportunity to refinance your existing loans at lower interest rates, if the government has reduced repo rates. However, it is important to check the terms of your existing loan to look out for any pre-payment charges or other fees.

6. Focus on the long-term

Think of investing like planting a tree. You wouldn’t dig it up just because a storm knocked it around a bit. You water it, care for it and work towards it regrowing over time. Similarly, your investments need time and patience to potentially yield results.

Conclusion

Knowing what to do during a stock market crash can help you prepare mentally, emotionally, and financially for the ups and downs of investing.

Remember, a crash brings both risks and potential opportunities. The key is to have a plan, stick to it and be resilient. Investing is not about avoiding storms but learning how to navigate them.

FAQs:

What is a stock market crash?

A stock market crash is a sudden and sharp decline in stock prices across a large part of the market. It can be triggered by a combination of economic, financial, geopolitical, or psychological factors. The situation often worsens when investors panic and rush to sell, which further drives prices down in a short span of time.

Do you lose all the money if the stock market crashes?

The value of your investments will typically go down during a market crash, but you will not necessarily lose money in the long term, as markets tend to recover over time*. You will lock in losses if you sell your investments during a downturn. If you hold onto your investments, they can potentially recover over time, especially if they are in fundamentally strong companies.

*Past performance may or may not be sustained in future

What causes the stock market to crash?

Several factors can cause a stock market crash, including

• Economic recession or slowdown
• High inflation or sudden interest rate hikes
• Global events like wars, pandemics or political crises
• Financial scandals or large corporate bankruptcies
• Investor panic and herd behaviour