Last year in March 2020, we witnessed stock market crashes due to a pandemic. The pandemic is not yet over, and the expectation of the third wave may lead to another crash. The chances are less, but there is always a possibility.
If you have been in the market for more than two years, you have seen the highs of February 2020 to the lows of March and April. Then, you have seen a sharp market recovery. There have been other similar crashes in stock market history. Some of the big ones are:
- 1980 – Interest rate hikes
- 1987 – Introduction of computerized trading
- 2000 – The dot-com bubble burst
- 2007-08 – Prime rate lending
If you study all these crashes, there are a few key lessons. In this article, we will talk about lessons from market crashes.
Never panic sell – When you invest in equity, you should know why you are investing and for how long? We are investing to increase our capital and for X number of years. Understand the market always goes up, but it is never a straight line. There will be corrections and crashes in the journey. When a market crash happens, you should not panic sell. Everyone in the market may be selling. Even the news channels may be talking about the bad times but don’t sell your holding.
The only exception here is if you are near to your investment goal. In this situation also, sell at the start of the crash. Do not sell after you have lost a significant percent of your capital.
No one knows when the reversal will start – If you only look at the March 2020 crash, the market touched pre-crash level fast. Here, the price reversal happened within a few months. It is not always going to happen. After the 2008 crash, it took the market more than 12 months to get back to the same level. You cannot assume, every time the market will recover quickly after a crash. Hence, don’t pour in everything you have in your savings or emergency account to double your money. No one knows when the reversal will start after the next crash. It would be months or a couple of years. As you don’t panic sell, you don’t put in all your money during a crash.
The power of SIPs – You may ask, then what to do during a crash. The first thing you need to do is continue your SIP. Studies have shown investors stop their SIP both during the market crash and when the market is at its peak. You do SIP to ensure you buy both at highs and lows. However, it is just human tendency to not invest at such times.
Continue your SIP even during a market crash. If you have some extra cash that you don’t need in the near future, you may consider investing it in the right stocks. If you plan to invest in direct equity and are not an experienced investor, better take professional help.
Emotion is the biggest enemy of investors during such times and in general. Hence, we created Jarvis Invest, an AI-driven platform that eliminates emotions from investing.
Make you understand the risk you are taking – During market crashes, the smaller companies are most impacted. Most small and mid-cap companies will see share prices going down significantly. If your portfolio consists of only small and mid-cap companies, your portfolio bleeds red. For the same reason – it is always said small and mid-cap companies come with higher risk. Such times tell you you risk appetite. It is a hard way to learn. You should always invest based on your risk profile.
Sticks to the basics – The major problem during a market crash is that investors start speculating. If the share price falls by 20%, you speculate it will increase the next day. If the price increases, you contemplate it will fall, as the others stocks are going down.
The key is that you stick to the basics of investing. All you have learned from the talk shows and the articles around investment, it is time to implement the learning. Market crashes teach us that those who stick to the basics gain the most.
Build up cash – Cash is the king in such times. Hence, you must build a fund for market crashes. If you can invest Rs 30,000 per month in equity, keep a small percentage of it in the stock emergency fund. Somewhere around 5 to 10 percent should be good enough.
A crash does not come every year. Hence, you can use this fund in major corrections as well. During crashes, you get a once in a lifetime buying opportunity. As mentioned above, you should follow the basics. One of the basic principles of investing is that you should never invest in equity by borrowing money. Hence, it is essential to have cash.
Diversify – We talk so much about diversification, and only those who have seen the market crashes understand the reason. It is not just about diversification within equity. You should invest in different asset classes. Invest in gold, bonds, debt funds, etc.
Some of the instruments (gold) have an inverse relation with equity. When the equity price falls during a crash, some of these instruments will be increasing. It gives you a double cushion – all your investment is not bleeding in red, and you may withdraw your investment without losses. If required, you can sell them and buy stocks.
We hope the market does not crash anytime soon, but if it does, you know what you need to do – you know how to sail through the rough sea.