7 Simple Steps to Take When the Stock Market Is Down

Today is Friday the 13^th. So in honor of this unlucky day, I thought I’d write about what to do with your money when things go wrong, specifically when the stock market tanks. After all, we all know that adulting is fraught with the unexpected. Learning what to do when things go wrong can make adulting so much easier.

I have written numerous posts on the importance of investing. In those posts, I have repeatedly said that, in the long term, stock prices have always gone up. It’s one thing to say that, however. And it’s another to believe it when you have thousands of dollars invested and the stock market crashes or even just declines a bit. If the stock market goes down, what should you do? And does that advice change depending on how much the market goes down? Or when you need the money? Read on for the answers.

Stock Market Terminology

Before I dive into what to do when the stock market goes down, it may be helpful to go over some terminology. You’ve probably heard of the terms “bear market” and “bull market.” I’ve always found these terms super confusing to keep track of. To put it simply, a bear market is when financial markets go down for a sustained period of time. Often, a bear market is classified as a decline of 20% or more from the stock market’s most recent peak. In contrast, a bull market is when financial markets go up for a sustained period of time. 

No one is 100% sure how those terms came to be. However, the theory is that it’s based on how bears and bulls attack. Specifically, a bear swipes down when it attacks while a bull thrusts up with its horns when it attacks. Pretty morbid. 

Related terms that are helpful to know are “market downturn” and “market correction.” A market downturn is pretty straightforward. It refers to a decline in financial markets that can sometimes turn into a bear market. 

A market correction is a more nuanced term. It generally refers to a market declining by more than 10% but less than 20% from its most recent peak. In some cases, it can mean a return to a more stable equilibrium in prices. In other cases, it can turn into a bear market. And in still others, the market may reverse and start growing again.

How Often Does the Stock Market Go Down?

Now that we know these terms, how do they apply to the real world? How often do downturns, bear markets, and corrections actually happen?

Again, the stock market consistently goes up in the long term. However, there’s a lot of market volatility in the meantime. In fact, between 2002 and 2021, a stock market correction or bear market happened in 10 out of 20 years. However, in all but 3 of those years, the stock market still ended in the positive by the end of the year.

Moreover, the average bear market lasts only 15 months. While it can seem like an eternity when it’s happening, it’s helpful to keep the time horizon of your goals in mind. Many of us are investing for long-term goals like retirement, so market dips or even a sudden drop won’t necessarily derail our goals.

Consequently, stock market declines are common and generally short-lived. They can even benefit you if you consistently invest! More on that below.

What To Do If The Stock Market Goes Down

Stay the Course (or Even Buy!)

If the stock market goes down, your first step is to take a deep breath. Your second step is to do nothing. It may help to remember one of Warren Buffett’s most famous quotes, “Be fearful when others are greedy, and greedy when others are fearful.” Why does Warren Buffett say this? 

He says this because arguably the best time for a long-term investor to buy stocks is when market values are low. When stock prices are high, there’s less opportunity to earn big returns. In fact, the best days for the stock market often follow the worst days. If you sell your investments at a lower price, you lock in that lower price. However, if you stay the course, you can capitalize on the upward trend of the stock market after a correction.

Want more evidence? J.P. Morgan found that if someone invested $10,000 in the S&P500 on Jan 1, 2002, they would have $61,685 by December 31, 2021 if they never took their money out of the stock market. However, if they missed the 10 days when market conditions were best during that time (often after stock market corrections), they’d only have $28,260! That means out of almost 20 years, only 10 days made the difference of $33,425 in gains!

Set Up Automatic Investing If You Haven’t Already

This is why, according to financial experts, your best course of action during a downturn is generally to stay the course. Keep regularly investing and don’t take your money out. Just keep doing what you’re doing. If you aren’t regularly investing, this may actually be a good time to set up automatic investing. You can buy stocks at a discount while the market is low and remove the temptation to make changes because the investing is being done for you.

Finally, many people who take their money out of the stock market don’t put it back in. There’s a temptation to try to time the market. However, none of us have a crystal ball and, again, missing out on a few key days can have a major impact on your long-term investments. So ignore the temptation to predict the right time to re-invest. Successful investing is generally boring and simple: invest consistently in a diversified pool of investments, mostly index funds and ETFs.

Revisit or Create a Financial Plan

If you don’t have a financial plan, it’s a good idea to consider creating one. A financial plan outlines your long-term financial goals and investment strategy. It doesn’t have to be complicated. In my case, my long-term goals are to invest 15% of my gross pay for retirement in broad market index funds like the S&P500 with the goal of retiring when I’m 65. 

I also have a goal of saving at least an additional 10% of my income in high-yield savings accounts, CDs, treasury bills, and other safe places for short term goals like putting a down payment on a house.

It might feel silly to write down just a couple of paragraphs. However, when market conditions change, you don’t want to change all of your investment decisions with it. Having a financial plan reminds you of why you’re investing in the first place. If you can remind yourself that you don’t need the money you are investing for 5 or more years, it’s easier to take that deep breath and keep your money where it is.

Even if you are near or in retirement, remember that you will hopefully live for far more than 5 years! You’ll want that money for a long time. So even in that case, your time horizon is still long. Spend a little while writing down your goals and how you intend to meet them with your savings and investments. Then revisit your plan when you’re tempted to abruptly change course.

Consider Tax-Loss Harvesting

There are times when selling stocks may be useful on a limited basis. This is the case if you have an investment brokerage account where you have to pay capital gains on any returns. If you just have retirement investment accounts, this will not apply to you and you can move to the next section. 

With tax loss harvesting, you sell an investment at a loss. That loss offsets any gains you earn in that tax year. As a result, your capital gains taxes will be lower. If you don’t have any gains, you can carry those losses forward to the next year.

Ideally, you should use the money from selling your investment to purchase a similar investment. This is a great way of staying invested in the market, keeping your portfolio diversified (assuming it was diversified to begin with), and earning returns once the market starts on an upward trend.

Rebalance Your Investment Portfolio If Needed

Sometimes stock market declines hit different asset classes or different sectors of investments harder. For example, when the tech bubble burst, technology stocks dropped especially dramatically. Or sometimes bonds do well while stocks fare poorly. This can mean that a portfolio that was once very diversified is now heavily skewed in value towards particular asset classes or industries.

Consequently, stock market declines and increases are the perfect opportunity to take a look at your asset allocation. Do you have the right balance of investments for your risk tolerance? Do you have too much of one financial product and not enough of another?

Ideally, you want a diversified portfolio that has a range of investments across different business sectors, sizes, and locations. For example, the S&P500, while not diversified in terms of country or company size, is a good way of getting diversification in terms of industry and location within the U.S. In general, index funds are an easy way to create diversification in your portfolio. Depending on your goals, risk tolerance, and time horizon, you may also want different types of financial products like stocks and bonds. 

For some people, this will not be necessary. For example, if you have a target date fund, your investments will be diversified for you. Moreover, most young people will want little to no bonds in their portfolio so that kind of diversification may be less relevant.

If you’re not sure whether you’re diversified or how you should be diversified, it may help to talk to a financial advisor. Robo advisors can even help with diversifying your portfolio. 

Contribute To Your Emergency Fund

While it’s always tempting to pull your money out of the stock market when things look bad, it’s extra tempting if you have no cash reserves to fall back on. This is especially the case if you are in or nearing retirement. This is one of the reasons that it’s so important to have an emergency fund that will cover 3-6 months of bare bones living expenses.

If that sounds intimidating, start by saving $500 in an emergency fund. Even a small cushion can help you weather a less than ideal financial situation so you don’t have to rely on credit or pulling money out of investments at a loss.

And remember, the stock market should only be used for long-term goals that are 5+ years away. If you’re planning on using that money sooner, you should start transitioning any money you need out of the stock market and into safer investments and savings locations like high-yield savings accounts, money market accounts, CDs, and treasury bills.  

Consider Talking to A Professional

Have you ever noticed that when you have a problem you feel so much better after telling someone about it? A certified financial planner (CFP) can help you get perspective on your financial situation. Plus, they can provide sound advice from their own experience weathering financial crises. A CFP doesn’t just help you understand investment options, they can also help you make financial goals and do tax, retirement, and estate planning.

While any time is a good time to talk to a CFP, their advice may be especially useful during a downturn. 

This article from Forbes provides helpful guidance on how to find a good financial advisor. In particular, make sure their focus is on your financial wellbeing and not peddling their preferred products. If they earn a commission from selling you, for example, whole life insurance and are pushing you to buy those products, run far away.

Should I Take My Money Out If the Stock Market Crashes?

I went over what to do if the stock market goes down. But what if it really crashes? Like goes in the toilet, 2008 financial crisis crashes? If you have a lot of money in the stock market (or what feels to you like a lot of money), the impact of a stock market crash on your emotional wellbeing can be profound. It feels like your money is going up in smoke. However, even in such cases, the advice above holds. Take a deep breath and stay the course to the degree that you can.

Hopefully you don’t need the money you’ve invested for 5 or more years. The good news is that even after big crashes, the stock market has generally recovered in 5 years or less. After the 1987 and 2008 crashes, for example, the S&P500 recovered after two years. After the 2020 crash, it took 6 months to recover. The 2000 tech bubble involved a bigger fall and took longer to recover—7 years. These reflect all the largest declines over the last 50 years. So there’s a good chance your investments will recover if you give it a few years. 

The key is to prepare yourself by only investing money you need 5 or more years in the future, if possible, and building your emergency fund to help ensure you can keep that money invested for 5 years.

Should I Take My Money Out of the Stock market If I’m Nearing Retirement?

If you’re nearing or even in retirement, much of the advice above still applies. Again, hopefully your retirement investments will last you many years. Just because you’re planning on retiring in, say, 1 or 2 years, doesn’t mean you will be taking all of that money out at that time. Consequently, the time horizon for much of your retirement plan will likely still be very long-term.

Thus, if you can, try to avoid taking money out of the stock market. As long as it doesn’t mean relying on credit. Use your emergency fund or perhaps consider working a little longer. Staying the course is the best way to make sure you don’t miss out on future gains and avoid locking in losses. 

If you have to take money out of the stock market, focus first on bonds and other fixed income assets. Then turn to your taxable accounts like 401Ks and traditional IRAs. You’ll likely have lower income and pay less taxes in a worse stock market year. Save your post-tax accounts like Roth IRAs for last.

Final Thoughts on What To Do If the Stock Market Declines

It can be stressful to be invested in a volatile market, even more so if you are seeing constant headlines about a financial crisis looming or in progress. However, it’s important to keep your investing goals in mind when this happens. Remember that investing is a long-term endeavor and that over periods of 5+ years, it’s one of the most reliable places to put your money. 

Moreover, the best days for the stock market often follow stock market drops. So while it’s tempting to take your money out of the stock market when there’s a downturn, do your best to resist the temptation. 

I hope you have found this information helpful! If you liked this article, please consider liking, subscribing or sharing with others. It’s always a huge help! And if you’re interested in related content, check out my articles on how to open an investment account, investing for retirement, and money-saving tips.

Remember that I’m not a financial advisor. This information is solely shared for informational and entertainment purposes. Before making any decisions, speak with a financial professional.