Staying calm in a market crash: a plan before you need it

Markets fall from time to time, sometimes sharply. Your reaction to a fall is often a bigger influence on your long-term results than the fall itself. This article explains why we tend to act badly in a downturn, what history tells us (and does not), and how to prepare a plan now so that you can stick to it when it counts.

Falls are a normal part of investing

Declines happen regularly. A fall of 10% or more, often called a correction, occurs fairly often, and a fall of 20% or more, called a bear market, happens every several years on average. Some have been much deeper. For example, the US stock market fell by roughly half in the early 2000s and by more than half in 2007 to 2009, and by around a third in a matter of weeks in early 2020. Recoveries varied: some took months and some took years. These are approximate figures, intended to show scale, and they refer to one market. Other markets have had different experiences, and nothing guarantees that a future recovery will be as quick or as complete.

The arithmetic of losses

Losses are harder to recover from than they look. A fall of 20% requires a gain of 25% to get back to even. A fall of 50% requires a gain of 100%. This is one reason why diversification and an appropriate level of risk are important.

Why we sell at the wrong time

Several well-known behaviours push us toward poor decisions.

• Loss aversion. Losses feel roughly twice as painful as equal gains feel good, so a fall seems worse than a rise seems good.
• Recency bias. We assume that what has just happened will continue, so a fall feels like the start of a permanent decline.
• Herd behaviour. When everyone else is selling and headlines are alarming, staying put feels dangerous.
• Hindsight bias. After the event, it looks as if it should have been obvious, which leads us to think we can time it next time.

The result is a familiar pattern: investors buy when markets feel good and prices are high, and sell when they feel awful and prices are low. Selling after a fall turns a temporary loss on paper into a permanent one, and recoveries often begin before it feels safe to return.

Prepare before you need it

The best time to plan for a crash is when markets are calm.

1. Keep an emergency fund. If you have cash for unexpected expenses, you will not be forced to sell investments to pay bills.
2. Choose a sensible allocation. Pick a mix of shares and bonds that you could live with in a large fall. If a 30% drop in your portfolio would make you sell, your mix is too aggressive.
3. Match risk to time horizon. Money you need within a few years should not be in assets that can fall sharply. Long-term money has time to recover.
4. Write a plan. Record your goals, your allocation, and what you will do when markets fall. Include the reasons. Re-read it when you feel the urge to act.
5. Automate contributions. Regular investing continues without a decision each time, and buys at lower prices during a fall.
6. Limit how often you look. Checking your portfolio daily during a downturn increases stress without improving decisions.

What to do during a fall

• Pause before acting. Give yourself a waiting period, such as a few days, before making any major change.
• Revisit your plan. Has anything about your goals, income or timeline actually changed? If not, a market fall alone is not a reason to change course.
• Rebalance if it fits your plan. A fall can leave your mix with fewer shares than intended. Rebalancing means buying some, which is uncomfortable but consistent with the plan.
• Keep contributing, if you can. Buying during a fall can improve long-term results.
• Avoid predictions. No one reliably forecasts the timing of turning points, including professionals.

When selling is reasonable

Staying invested is not the same as ignoring everything. There are good reasons to sell: you need the money for its intended purpose, your goals or risk tolerance have genuinely changed, you hold too much of one asset, or you have learned that an investment is not what you thought. The key is that the decision follows your plan, not your fear.

A note of honesty

Markets have recovered from major falls in the past, but this is not guaranteed and can take years. A long-term investor still needs to be able to live with the possibility of a prolonged slump. That is why matching risk to your time horizon is the best protection.

Common mistakes

• Selling everything after a large fall.
• Checking prices constantly and reacting to headlines.
• Having an allocation that is too risky for your temperament.
• Not having an emergency fund, which forces sales at bad times.
• Trying to time the bottom and the recovery.

A short checklist

• I have an emergency fund and a written plan.
• My allocation is one I could hold through a 30% fall.
• Contributions are automatic.
• I have a rule to wait before making big changes.

Preparation is what makes calm possible. Decide now, while markets are quiet, how you will behave when they are not.