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What should we do? Sell before it crashes even further? Put it all in cash under the mattress and wait for the world to return to normal? PANIC: read the news to get insight and feel even worse afterwards? Engage with the doomsayers predicting the end of capitalism?
Here's how Katie and I have trained ourselves to react when the market drops and why doing the opposite of what everyone else does is the route to financial success.
The market has crashed
How would you react to your investments going down that dramatically? What would you do? How do you think the average person reacts?
A recent survey in Canada revealed that 25% of people invested in the stock market were thinking of selling their shares by the end of the year. They are worried the market is going to drop further! Better to get out now?
It is hard to keep your cool when the market is crashing and the newspapers are selling doom and the end of the world as we know it.
Panic and sell
The worst thing you can do in a situation like this is to panic and sell, but this is what most people do. Human nature vastly overexaggerates the fear of loss, and we do crazy things to avoid it.
If you sell now, you are actually making a loss that until then were only on paper. If you don't sell, your "losses" aren't real.
Let me give you a metaphor from the housing market. If the housing market collapses by 20% what has actually changed for you? You still live in the house; it might be worth less, but you still own it!
If the house you live in right now goes down by 20%, are you going to panic sell it because the market might go down further? Even if your house was worth £300,000 and you had "lost" £60,000 off the value would you sell it before it slumps further?
No because it is a virtual loss. You still own the same number or amount of house!
When the market drops it means the value of your shares at that point has dropped but you still own the same number of shares or productive assets.
If you sell, you get the current market value of those shares and you make real or "crystalise" that loss. Then you have really LOST that much money. If you hold onto the shares the market will inevitably go back up and when it does your shares will be worth more. You will still own the same number of shares.
What should you do if the market crashes and you see the value of your shares going down?
Stocks and shares are on sale!
Do the opposite of what everyone else does and buy more because they are on sale. Lots of other people are panicking and selling their shares which is the perfect time to gobble them up at a discount.
The time to be greedy is when everyone else is fearful. The time to be fearful is when everyone else is greedy.
When Katie and I see the market drop we look around to see what cash we have spare to buy more stocks and shares whilst their price is down.
The market on average over time always goes up. Therefore if you buy the stocks and shares when they are low you are getting a bargain that will increase in value over time. Important! We are talking about investing in low cost, diversified index funds here. Not individual stocks and shares or managed funds. If you're not sure what I'm talking about here, read our investor series explaining index funds that starts here.
Katie and I are just about to sell one of our investment properties. This will bring a large chunk of cash in, £118,000 in total. The market is down, yes currency exchange rates have moved against us, but time in the market always beats timing the market.
We just need to get that cash and get into the market. Stocks and shares are on sale, and it is time for us to buy.
Stop reading the news
Panic articles sell newspapers and get us glued to the TV. The media knows this so the more they hype the panic the more we watch, the more money they make through advertising revenue and the happier they are. However, there is a cost of this cycle to our mental health.
You see articles and news coverage predicting crashes and huge drops (which you click on and read; making them money) and it makes you doubt your decision to buy and hold. It makes you panic about what is going to happen next.
Every single year at Chautauqua (a financial independence retreat, my first was in 2016) people have come with the story that stocks are overpriced and will crash, and we shouldn't buy. The stock market goes up by an average of 10-12% every year. Again, this is if you are invested in low cost, well diversified index funds. This doesn't apply to individual companies or actively managed funds.
The media makes money out of scaring you. Stop letting them. The stories in the media, the rhetoric in the public doesn't seem to match the reality of the situation.
Yes, the market is down this year by 20%. This is a normal part of the cycle. On average the market crashes like this every 5-7 years. It is going to happen again and again and again.
This is your opportunity to buy. Stop listening to the media. Follow a long-term investing strategy and buy and hold forever.
Investing for the long term
I am 44 and I will have my money invested for the rest of my life because I live off the dividends and capital growth of those investments. If I take it out of the market and go to cash, I will run out of money.
On average people in the UK live till they are 82 so I have 38 years left to live. I am investing for the long term. Even if you are 60 or 70 now you have a decade or two left to invest.
Over a 15-year period there has NEVER been a time where the market has gone down. On average year and year, it goes up by 10-12%. It always crashes and then it always surges back. This is the cycle we go through.
Do you think I am going to remember the 20% drop in 2022 when I am 75 years old? It will be a minor blip in the market's history.
The Donegans strategy
Our strategy is to buy a simple index fund such as the Vanguard FTSE Global All Cap Index Fund and hold forever. If the market crashes we will see what spare cash we have (check down the back of the sofa, see what is in our accounts) and buy more.
If you are living off your portfolio at the point the market crashes, then you can use some of your emergency fund to get by until the market recovers (which it always does).
We avoid the media and focus on making long term strategic decisions rather than short-term knee-jerk decisions based on fear. Media hype is the enemy, and we refuse to be drawn in.
What is your strategy for investment?
What is your strategy for investment? How will you react when the market crashes? Because it WILL crash again. There is always a market crash coming we just don't know when or what will trigger it.
You need to know what your long-term game is when you get into the game of investing. if you don't then you will be swayed by market conditions, the media or by friends telling you what to do.
My challenge to you is to think through your own long term strategy for investing and write it down. If you ever wobble then go back to this written document and read it. Follow what you said you were going to do in the calm times not what you feel like doing when you are panicking.
I would LOVE to know what your long-term strategy is and how you are responding to these market conditions. Please write me a comment below and let me know what you think!
Thanks for reading and if you want to start at the beginning with our guide to investing, click here or sign up to come to the next free Rebel Finance School.
This is not financial advice. We are not regulated financial advisors. You are responsible for your financial decisions and future. Please read our full disclaimer here.