What to do when the stock market crashes

In 2024, it seemed like the stock market went in just one direction—up. That notion has been shattered in the past few weeks. The Nasdaq is well into correction territory. The Japanese stock market tumbled 12.4% on Monday alone. Legend has it that the great banker, John Pierpont Morgan, was once asked what was going to happen in the stock market. His answer: “It will fluctuate.”

Stock market volatility is nothing new. But investors have hardly mastered their nerves and emotions in the face of it. Quite the contrary. Vast sums of money are routinely lost (and won) during gut wrenching declines in the stock market. That has never changed and probably never will. What is an intelligent investor to do? Here are my five rules for surviving—and indeed thriving—during market downturns.

1. Stay as far away as possible from financial media and pundits. And resist the temptation to check your portfolio.

Are you saying I should just bury my head in the sand? Yes, I am. Now would be an ideal time to forego the news. Pick up a few good books and read them instead. Or fine tune your golf swing. Or take up a new hobby. Do anything but pay attention to the stock market.

Here’s why. Humans absolutely abhor losses, an innate tendency so strong that economist have a name for it—loss aversion. We hate losing money so much that we make very irrational decisions to avoid losses. So not only will you lose sleep but you may end up losing your wallet by panicking and selling at the worst possible moment or by trying to time the market.

2. Learn to think like a contrarian investor by embracing stock market declines.

The greatest investors relish market declines because they understand that true bargains arise when everyone else is in a state of panic. Warren Buffett famously urged, “be fearful when others are greedy and be greedy when others are fearful.” Being greedy when others are fearful is easier said than done, but you must inculcate just such a mindset. If you are saving money for retirement, market declines are a blessing. The younger you are the truer this is.

I have found it helpful to view my wealth not in dollar terms but rather counting the number of shares I own. If the price of a stock or fund you own has fallen 50%, does it really mean your wealth has been cut in half? I would argue not. Your ownership stake in real companies paying real dividends has not changed one iota. In most cases, the dividends you can expect to receive remain the same. And if you are reinvesting those dividends or are seeking to buy more shares, the price drop should properly be viewed as a sale. In short, focus on the shares you own, not their value.

3. Reframe how you view risk.

Academics and the financial industry view price volatility as risk. Stocks are riskier than bonds and cash because stock prices are much more volatile. You don’t have to accept this view of risk, because it’s deeply flawed. Nearly everyone views stocks as riskier when stock markets are tanking. But unless you have a short time horizon—and if you do, you shouldn’t be putting that money in the stock market—stocks actually become less risky as prices fall.

If you have a proper view on stocks—as ownership in businesses that return cash to its shareholders in the form of dividends and buybacks—then it should be clear that the less you pay for a given ownership stake, the higher will be your ultimate return on investment.

For example, imagine a stock is paying $2 in dividends per share each year. If you invest in the stock at $100 per share, you’ll receive 2% of your investment in the form of dividends over the next year. Now imagine that the stock market tanks, causing the stock price to fall to $50 without a significant change in business fundamentals. If you buy the same stock, you can now expect a return of 4% in the form of dividends. Your expected return has doubled! In short, price declines reduce the risk of owning stocks.

An important caveat is needed here. All bets are off when it comes to individual stocks. A major price decline in a given stock may reflect a deterioration of fundamentals unique to that company. But if you prudently invest in a diversified manner through index funds or diversified stock funds, large price declines ought not instill fear. Instead, the intelligent investor realizes that the risk has actually fallen and considers buying more.

4. Remind yourself of the virtues of stock ownership by revisiting investment classics.

What are these virtues? For starters, a broadly diversified portfolio of stocks has returned about 7% per year above inflation over the long run. By the rule of 72, that means that stocks roughly double in value every ten years. By comparison, long-term government bonds and T bills return just 3.6% and 2.5% per year after inflation.

Since WWII, the longest period an investor had to wait to recoup her original investment in stocks, with dividends reinvested, was 5 years and 8 months. And over 10-year time periods, stocks have bested bonds and cash about 75% of the time. Finally, though bonds and cash seem to be safer than stocks, bonds are actually riskier than stocks over longer time horizons due to inflation.

My go to resource on the virtues of stocks for the patient investor is Jeremy Siegel’s classic, Stocks for the Long Run: The Definitive Guide to Financial Market Returns & Long-Term Investment Strategies. When markets go berserk, I find that thumbing through Siegel’s book helps me regain a healthy perspective and sense of calm.

5. Train yourself to sit still and do nothing (financially).

If you ignore all my other rules and just follow this one, you’ll do fine. However, adherence to the other rules makes following this one far easier.

French mathematician and philosopher, Blaise Pascal, said: “All of humanity’s problems stem from man’s inability to sit quietly in a room alone.” He could have been speaking of investors. Like so many things in investing, it is counterintuitive that “doing nothing” would be the road to riches. In almost every other area of life, inaction in the face of threats is the wrong approach. Why is it different when it comes to investing?

At its root, investing is about the miracle of compounding. That is why the first chapter of my children’s book is on compound growth. Charlie Munger hit the nail on the head when he said, “The first rule of compounding: Never interrupt it unnecessarily.” There are many ways to break Charlie’s rule. When you try and time the market…guilty! When you sell in fear during a bear market…guilty! The latter is especially damaging as investors tend to sell at the worst time, often near market bottoms.