How to React to Stock Market Panic

Unless you religiously avoid the news, you’ve no doubt heard that the stock market took an absolute beating in the last 2 weeks, and the road is shaky going forward.

The Dow Jones (a good measure of the market’s largest players) closed at 12,724 on July 21st, and finished at 10,813 as of Monday, representing a drop of more than 15% in a little less than 3 weeks.

In dollar terms, if you had $100,000 in your 401(k) and were fully invested in the general market, you could expect to have about $85,000 in the account today. That’s a painful reality to face for anyone, even long-term investors.

The reasons for the most recent drop are many:

  • The fight in Washington, D.C. over raising the U.S. debt ceiling.
  • S&P’s downgrade of U.S. debt for the first time in history.
  • Traders taking profits.
  • Fear.

I’ve broken my own rule (don’t pay attention to the markets) and have followed the story with some interest, though I have not executed any trades. I’m staying put because that’s the plan I’ve committed to. My advice for riding out this rough patch remains steady and simple:

Understand your portfolio. What kinds of instruments are you invested in? If you’re holding cash, money market, treasuries, bonds, and even some types of stocks, a market crash will affect you very differently than a person who owns only stocks. In fact, if the majority of your money is in “low-risk” investments, your panic is probably unnecessary.

Maintain perspective. This is a chart showing the Dow Jones from roughly 2005 through today (from Google Finance):

Although this month’s drop is eerily reminiscent of the plummeting markets in 2008, it’s important to understand how far we’ve come since the lows of 2009. If you want a larger perspective, look at the Dow from 1980 to today.

Exit carefully. If you’re planning your escape from the markets, be wary–most of your losses may already be on paper, and getting out could spell missing out on a short-term recovery. Researchers have long understood that a down market is more painful to the investor than an up market is pleasurable, but working through the emotions is what will set you apart.

But do cut your losses. If you have a stop price you’ve pre-determined before the crash and that price is reached, don’t think twice about cutting investments loose. The important thing is to follow the strategy you’ve outlined for yourself and not get caught up in the moment.

Enter aggressively. If you have cash on the sidelines, downward spikes may be the best opportunity you’ll have to get into stocks at cheap price. If most of your portfolio is in liquid assets, seriously consider this as the time to buy, and use the rebound to give your portfolio a lift.

All of this should work, unless of course, it turns out that we’ve barely scratched the surface on this crash and the worst is yet to come. Let’s hope not…

This post is not investment advice and not intended as anything but my own opinion–do your own homework and consult professionals before you make any moves that affect your money.

3 thoughts on “How to React to Stock Market Panic

  1. If you are invested within 401K, you have automatic advantage of dollar cost averaging, so in down markets you are automatically buying at lower price AND getting a higher number of shares since most of us contribute fixed amount on bi-weekly basis, with an employer match/contribution.

    If you are in your 30’s, you can’t withdraw that money for at least another 20-25 years

    1. Excellent point, though I’m afraid more and more companies are getting rid of their 401k plans entirely, which means we have to rely on our own systems. I recommend that anyone without a 401k plan research dollar cost averaging.

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