How Will You React When the Next Stock Market Crash Happens?

Stock market crashes are the financial world’s equivalent of a stormy sea. They’re unpredictable, often unsettling, and yet entirely inevitable. But just like seasoned sailors don’t abandon ship at the first sign of waves, savvy investors know how to ride out the turbulence. So, how will you react when the next stock market crash happens? Will you panic and bail, or will you keep your cool and stay the course? Let’s dive into the psychology of market crashes, their history, and strategies to help you weather the storm.

The Highs and Lows of the Stock Market

The stock market is one of the best places to achieve long-term growth. Over decades, it has consistently outperformed most other asset classes, delivering inflation-beating returns that help build wealth. But it’s not a smooth ride. Markets rise, and markets fall – that’s the nature of the beast.

The Barclays Equity Gilt Study used records dating back to 1899 and has one key overarching conclusion: over the long-term, equities have significantly outperformed both cash and bonds in terms of average returns. According to the study, UK equities have delivered an average annual ‘real’ return (over and above the rate of inflation) of 5.1%, significantly outpacing the 1.2% average for government bonds (gilts) and the 0.8% for cash. However, that average masks the volatility along the way. Some years see spectacular stock market gains, while others suffer gut-wrenching losses. For every roaring bull market, there’s a bear market lurking somewhere ahead. Understanding this cyclical nature is key to avoiding panic when the inevitable happens.

What Is a Stock Market Crash?

A stock market crash is defined as a sudden, severe drop in stock prices over a short period, typically more than 20% from recent highs. Crashes are often triggered by economic shocks, political upheavals, or investor panic. While stock market corrections (a drop of 10-20%) happen fairly regularly, crashes are rarer but far more dramatic.

A famous saying from venture capitalist Marc Andreessen sums it up: “Volatility is a feature, not a bug.” In other words, market crashes aren’t anomalies – they’re part and parcel of investing. Once you accept this reality, it becomes easier to see crashes as opportunities rather than disasters.

A Brief History of Market Crashes

To put market crashes in perspective, let’s look at a few famous examples:

• The Panic of 1907. In 1907, speculative investments and financial mismanagement in the US led to a wave of bank and trust company failures, causing widespread panic and a sharp drop in stock prices. The New York Stock Exchange suddenly fell almost 50% from its peak the previous year. With no central bank to stabilise the system, financier J.P. Morgan personally intervened, paving the way for the establishment of the Federal Reserve in 1913.
• The Great Depression (1929): The granddaddy of all crashes saw the US market lose nearly 90% of its value over three years. It was a painful lesson, but the market eventually recovered, and those who stuck with it reaped the rewards.
• Black Monday (1987): On 19 October, in the US, the Dow Jones Industrial Average plunged 22% in a single day and global markets tumbled around the world. While terrifying at the time, the market bounced back within two years.
• The Dot-Com Bubble (2000): Overvalued tech stocks crashed, leading to a three-year bear market. Yet, the survivors of this era include companies like Amazon, which have since delivered enormous returns to investors.
• The Global Financial Crisis (2008): A housing market collapse and banking crisis wiped out trillions of dollars. But again, markets rebounded and reached new highs within a few years.
• The Covid Crash (2020). The Covid-19 pandemic sparked a widespread market crash in early 2020, with the FTSE-100 falling by over 30% as lockdowns and uncertainty gripped the world. Swift government stimulus and central bank action led to an equally rapid recovery, highlighting the resilience of financial markets even in unprecedented crises.

What’s the takeaway? Markets crash, but they also recover – sometimes faster than expected.

How Should You Prepare?

Now that we’ve established that crashes are inevitable, let’s talk about how to prepare and react. The key is to approach investing with a plan, not emotions. Here’s a brief rundown of our top ten tips to help you prepare for the next stock market crash:

1. Build an emergency fund. Before investing, ensure you have an emergency fund covering at least 3–6 months of living expenses. This safety net can prevent you from having to sell investments during a market downturn to cover unexpected costs. Knowing you have a financial cushion can also help you stay calm when markets are volatile.
2. Diversification is your friend. “Don’t put all your eggs in one basket” is more than a cliché – it’s a cornerstone of investing. Diversify across geographies, sectors, and asset classes. Hold a mix of stocks, bonds, property, and even cash to reduce the impact of any single market’s downturn. This way, when one part of your portfolio dips, another might rise to balance it out.
3. Maintain a long-term perspective. Successful investors know that investing in equities is always a long-term strategy. A 20% drop might feel catastrophic in the moment, but history shows that time smooths out these dips. Instead of obsessing over short-term losses, focus on your long-term goals, whether that’s retirement, buying a home, or funding your child’s education.
4. Don’t crystallise losses. One of the biggest mistakes investors make is selling in a panic. When you sell during a crash, you lock in your losses – there’s no opportunity to recover. Remember, a loss isn’t a loss until you sell. Keep calm and let the market do its thing.
5. Check your risk profile. Are you comfortable with the ups and downs of the market? If you panic at the thought of a 20% dip, your portfolio might be too risky. Understanding your risk tolerance helps you stay invested through turbulent times. Speak to a financial adviser to ensure your investments align with your comfort level.
6. Understand the range of outcomes. Markets don’t just go up or down; they oscillate. Know what to expect in terms of potential gains and losses. Historically, the worst one-year loss in the S&P 500 was nearly -40%, but the best one-year gain was over +50%. Having this perspective can help you keep your cool during rough patches.
7. Take advantage of ‘pound-cost averaging’. One effective strategy during volatile times is pound-cost averaging. By investing regularly, regardless of market conditions, you smooth out the highs and lows. It’s a disciplined approach that takes emotion out of the equation.
8. Educate yourself about market cycles. Understanding historical patterns of market corrections and crashes can help you manage your expectations. For instance, the average ‘bear market’ (a drop of 20% or more) lasts around 14 months, while ‘bull markets’ (periods of sustained growth) tend to last much longer. This knowledge can provide reassurance during challenging times.
9. Review and rebalance your portfolio regularly. Regularly review and rebalance your portfolio to ensure your asset allocation aligns with your goals and risk tolerance. For example, if stocks have performed well and grown to represent a larger portion of your portfolio than intended, consider rebalancing by selling some and reallocating to bonds or other assets. Rebalancing helps maintain a diversified strategy and reduces risk.
10. Tune out the noise. When markets crash, the media tends to amplify panic with doom-laden headlines. Resist the urge to check your portfolio obsessively or act on sensational news. Instead, focus on credible sources of information and remember your long-term strategy.

Stock Markets Always Recover

Here’s a comforting thought: stock markets have recovered from every crash in history. They’ve bounced back through world wars, political upheavals, financial crises, and even global pandemics. The resilience of the market reflects the resilience of human innovation and enterprise.

If you stay invested and keep faith in the long-term potential of the market, you’re likely to be rewarded. Those who sold out in panic during past crashes often missed the market’s best days, losing out on the eventual recovery.

Final Thoughts: Keep Calm and Carry On

When the next stock market crash happens (and it will), how you react could define your financial future. Will you panic, sell, and regret it later? Or will you stay the course, trusting in the market’s ability to recover and grow over time?

The key is to be prepared. Diversify your portfolio, understand your risk tolerance, and maintain a long-term perspective. Most importantly, don’t let fear drive your decisions. Remember, crashes are a feature of the market, not a flaw. If you stay disciplined and stick to your strategy, you’ll be well-positioned to weather the storm and come out stronger on the other side. So, when the storm comes, take a deep breath, trust your plan, and keep your eyes on the horizon.

If you would like to talk about any of the issues in this article or need more general help with your finances, please get in touch with us.

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