What should you do in a stockmarket crash?

I hate the word CRASH. But for the purposes of the headline above, let’s call this a mini-crash. As I write, the FTSE 100 share index has fallen by 10% in a week, the US stock markets are all down heavily as is almost every stock market across the world.

The press love it. Nothing sells papers quicker than alarming and negative headlines. How about this: “Financial Meltdown!” “Billions wiped off shares across the world!” And so on. the entire US economy has been labelled a “Ponzi Scheme” and the UK’s strong economic showing is a “Castle built on the sand.” We see these headlines and our immediate instinct is, “Ooh, I must read about that.” And like sheep, we buy the newspaper.

But what do you do when the stock market crashes? The more gracious phrase is “market correction”, by the way. How should you react when you go online to look at your ISA or pension statement and its value has fallen by 10% or more? Here are three options:

1: Panic and sell everything immediately?

…or move all your stocks into Cash? As you would imagine, I’m not a great fan of either strategy, but they do have one positive. You won’t lose any more money. If the market continues to fall, you’re safe. There is however one small problem. First of all, can you pull your money out quickly enough before the markets hit the bottom? Even if you manage to do so, when markets crash heavily, they tend to bounce back pretty quickly. In many instances in the past, the momentum of the bounce back has continued beyond the point of the initial fall. This causes a bull market (an expression used where markets power ahead like a charging bull). Anyone who had sold everything or moved their money into cash would be “outside the market” meaning they would not participate in the bull market, thereby crystallising their losses. By the time they get back in, they have missed the boat.

2: Keep calm and do nothing?

…leaving everything as is? Doing this takes some guts and faith that markets will return to normal, but history suggests that they usually do. The biggest market corrections have always been followed by a strong rally. Black Monday 1987, the Dot Com Crash in 2000, 11 September 2001 and most recently, the Credit Crunch in 2008. Markets tend to take weeks to fall and months or years to recover. But by sitting tight, staying calm and doing nothing, you get to participate in the rally as and when it comes. History has shown there to be rally after every market correction there has ever been, however with stocks and shares, there are no guarantees.

3: Buy like it’s going out of style?

…investing any spare cash in the markets?

I’m going to use residential property as an example here. We all understand residential property so try to remember when would have been the best time to have invested in residential property in the UK – taking a long term view. Should you have bought during a property boom or bust? If your thinking BOOM, then stop reading now because we will never understand each other and I can’t help you. If however you’re thinking BUST, please read on. You may think back to 1991, when interest rates were at an all-time high, when almost every house in London was For Sale, when interest rates hit 15%, when words like “negative equity” and “handing back the keys” and “repossessed” were on everyone’s lips. Hindsight is a great thing, but if you’d had the money at the time, and a crystal ball, you would have bought everything you could get your hands on. And today, you would be rich beyond your wildest dreams.

The stockmarket is no different. People tend to get on the bandwagon during a bull market; they see that people have made money and jump on hoping to grab some of the momentum. There’s nothing wrong with that. However the very best time to jump on the bus is after a crash – or should I say market correction. But it takes a special type of investor to have the guts to do that.

Akwasi Duodu, Independent Financial Consultant

Sterling & Law Group plc.

akwasi@sterlingandlaw.com