A stock market crash is defined as the sudden selling of stocks in response to some sort of trigger which causes panic, and thus more people sell stocks in a race to the bottom. In other words, there are suddenly far more sellers than buyers.
Historically, every two years or so, the market falls at least 10%, which we call a “correction." A stock market crash is usually defined as a decline of 20% to 30% or more. These occur roughly every eight to 10 years.
If we count back, the time from the dot-com crash in 2000 to the 2008 financial crisis was eight years, and then the time from 2008 to the 2020 crash was 12 years.
Bear markets are defined as sustained periods of downward trending stock prices, with the worst-affected stocks being growth stocks. This is usually triggered by a 20% decline from their near-term highs. For example, between 2021 and at least 2022, we have seen a downward trend in many growth stocks, even those held by Catherine Wood (Trades, Portfolio)'s Ark invest.
This decline has been driven by skyrocketing inflation, which is 7.5% and well above the Federal Reserve's historical 2% target. A suspected rise in interest rates is needed in order to curb inflation. Higher interest rates negatively affect the valuation of growth stocks.
Heading into 2022, we have a variety of macroeconomic factors which are coming to a head:
- Inflation
- Rising interest rates
- New Covid variants
- Russia-Ukraine conflict
- Supply chain disruptions
- Deglobalization
These factors together would be hard-pressed to not cause a stock market crash. Russian stocks have already tanked by 30%. Here are my top five steps on how to survive a stock market crash.
1. Keep perspective
The first step is to keep perspective. Market crashes are a part of the stock market game. Historically, despite the financial crisis and even World War II, stocks have risen higher over very long periods of time.
Any losses are only “paper losses” until you sell. The number one tip by legendary investor Peter Lynch is to “Know what you own." If you understand the businesses you have invested into, then this should help to give you perspective and comfort. As Benjamin Graham, would say "a stock is a portion of a company," not just a ticker symbol.
For example, Amazon's (AMZN, Financial) stock is down 22% from highs in January. Do I still order online from Amazon? Do I still see Amazon delivery trucks out daily? Is the business getting better? Yes to all of these, so I remain confident that any declines will be temporary.
2. Invest for the super long term
A great tip is to not check your stock portfolio daily. It is natural to feel like you want to “control” your portfolio. But the danger is that this can tie your portfolio performance with your psychology and self esteem. Thus, investing for the super long term can be beneficial. For example:
- Ark Invest has a five-year time horizon - and that's considered short in the hedge fund world!
- Warren Buffett (Trades, Portfolio) has a 10+ years to “forever” horizon.
3. Know your own psychology
This is a vital tip and one that is often overlooked. Most people think a stock market crash won’t bother them until they see their portfolio red and are losing sleep as a result. The key is to understand your own psychology and the type of volatility your comfortable with.
The majority of people are “loss-averse,” meaning we feel more pain from a loss than happiness from an equivalent gain. For example, how happy would you be if your portfolio was up 10%? Now compare this to how unhappy you would be if your portfolio was down 10%! For most people, the second feeling is much stronger.
I personally like to not invest any money which I cannot afford to lose. If losing the money would affect my lifestyle, I won't invest it. Also, keeping a strong cash position (at least 20%) is useful.
Surprisingly, investing memes can also help to ease any psychological pain by offering a “less serious” view of the stock market. Thus, it’s no wonder that memes have seen a major boost in popularity among the investment community over the past couple of years.
4. Diversify with the barbell strategy
Diversification is an overused term, but still it is very necessary to a well-rounded portfolio. When one asset class is going up, another is going down. I personally like to utilize the “barbell strategy."
This strategy gives your portfolio two sides, one side is very “safe” funds (S&P 500, World Equity portfolio, or even physical real estate, which offers rental cash flow). Then the other side has more volatile stocks and funds.
5. Stocks are on sale
Remember that generally, during a stock market crash, stocks may “feel” more risky due to perception biases, but they are usually trading at a discount and are thus safer investments than they would be at the top of the market cycle. Ironically, the most dangerous time to buy is when everything seems great and nobody is worried about risk. Of course, this is not a recommendation to “buy the dip," because we never know when the bottom will be reached. Morover, some companies might go into permanent decline.
