Sure as day follows night, stock markets will crash. We don’t know when. Often, we don’t even know why. But sooner or later, stock markets falter. The question is, what do we do when it happens?

Prepare

Most of the work is done long before the market crashes. It’s like running a marathon. You put in the hard yards for months so that you can run well for a few hours. Or as boxers say, “train hard, fight easy”.

Savvy investors build their strategies to withstand market crashes. We talk about these tactics frequently: 

• Make sure you hold a portfolio of different types of assets.
• Your portfolio should have exposure to different countries.
• Given your age, obligations, and goals, take on only as much risk as you’re comfortable with.

These tactics come into their own when markets turn downwards. A diversified portfolio means that not all your assets move in the same direction at once. Your American tech shares might fall while your gold ETF investments gain.

Of course, no strategy protects us completely from stock market crashes. But with robust planning, we can better handle market shocks.

Don’t panic

The temptation is real. Watching charts that were rising nicely suddenly turn downwards gives us all anxiety. We face a temptation to sell, sell, sell! Surely, we think, getting off this sinking ship will save me. And we would almost certainly be wrong.

Trying to time the market by selling whenever it turns negative is one of the surest ways to lose money. As the truism goes, “time in the market beats timing the market”.

The truth is, none of us knows when a dip is just a dip; a fall is just a fall; and a collapse is really a collapse. When we try to sell high and buy low, we invariably get it wrong. And we don’t have to get it badly wrong to lose out.

The data shows that missing just a few good days in the market can be very costly. Analysis of the S&P 500 shows that if you missed just the 10 best days of growth over the last 25 years, your return would be 4.54% instead of the 7.85% you’d achieve by simply buying and holding. 

Had you started with an investment of $100 000 and simply held on for 25 years, that sum would have grown to $662 870. Missing those 10 pivotal days slashes that amount to $303 820.

And the more good days you miss, the more you lose out on. Missing 30 of the best days or more means you may lose money over 25 years.

Source: YCHARTS 

See the wood for the trees

Successful investors frequently ride out market crashes with sheer patience and trust in the process they’ve committed to. However, some investors will choose strategic adjustments.

This demands striking a balance. To ensure a wise response, it’s critical to filter out the noise. And there will be plenty of noise! Stock market downturns have a way of drawing opinions from all directions. From your local coffee shop to social media, these opinions will find you. BUY! SELL! HOLD! Some of this guidance will be good. Some will be very, very bad.

Good investors tend to be highly capable of analysing good information and even better at ignoring bad information. 

This skill comes to the fore during times of heightened tension. Don’t try to respond to the storm of data that comes your way. Remember the sources and opinions you valued before the crisis hit.

You’re only human

We can avoid many of the costliest mistakes by pausing to remember that we’re all human. The relatively new field of behavioural economics highlights the many mistakes that all of us are prone to make in times of financial crisis, purely because of our human nature.

For example, we have a recency bias. That is, we place exaggerated emphasis on events that happened more recently. So we run the risk of letting that scary share price collapse last week overshadow what may be several years of growth. Rather, keep in mind that financial planning is a long-term endeavour.

Loss aversion is another of these quirks. Psychological studies show that investors experience the emotional pain of losing money more intensely than the satisfaction of gaining the same sum of money. In other words, the unhappiness of losing R100 is larger than the happiness of gaining that same R100. Following our loss aversion can lead to irrational decisions as our flight for safety costs us chances to profit.  

Economic crises can also spark our herd mentality. As with all biases, this has its place. Sometimes it’s wise to follow the crowd, but we should take a moment to ask if this is one of those times. Otherwise, we might just follow other investors off a cliff.

Perhaps riskiest of all in times of crisis is the overconfidence bias. We humans are prone to overstating our ability to predict where markets will go next. Be it a pattern we reckon we’ve spotted in tech share prices or a stock tip from a colleague ‘in the know’, we can be convinced that crystal balls exist. Hence, the handy reminder attached to financial services adverts worldwide: “Past performance does not guarantee future results”

Seize the moment

But it’s not all about playing defence. A crisis is often the mother of opportunity. As the saying frequently attributed to Winston Churchill goes, “Never let a good crisis go to waste”. Good investors understand that market shocks create opportunities.

This is a good time to remind ourselves of the principle listed above: Don’t panic. Taking advantage of opportunities is not a knee-jerk reaction. Instead, we can position ourselves to do it strategically.

For example, we may want to ensure we have the liquidity to grow our exposure to a safe-haven asset when riskier assets lose ground. And we want to be positioned to benefit when a market shock corrects itself.

Remember, rebalance

Sure as the next crisis will hit, there will be a recovery. Unfortunately, that is not the time to relax. As markets settle into a new phase, investors should revisit their portfolios to ensure they still fit their financial plans.

You can start with your equity-bond ratio. If you plan to hold, say, 60% of your assets in equities and 40% in bonds, that ratio will likely have changed by the time the crisis settles. Depending on the nature of the crisis, you may find yourself at 50%-50% or perhaps even 70% equities and 30% bonds once relative prices have settled.

Rebalancing means buying and selling investments to ensure you still hold the assets you want in the proportions you planned to.

Ready for the next one? 

Finally, we take you back to our first point: Be ready. If you weren’t prepared for the last crisis, you certainly aren’t alone. Treat that as learning a lesson the hard way. Then, prepare for next time.

Plan carefully, set your time horizons, seek advice where needed, and build a robust, diversified portfolio that serves your individual needs – including the need for a cushion for the next crisis.

The views and opinions shared are for informational purposes only. They are not intended to serve as investment advice and do not represent the views or opinions of Standard Bank. This information should be used as a starting point for generating investment ideas and should not be relied upon as the basis for making investment decisions. The Standard Bank of South Africa Limited will not be responsible for the results of any investment decisions made based on the views provided.