Why you shouldn’t care about a stock market drop if a recession hits

If you follow the news, you’re likely wondering whether recent volatility or frequent recession headlines means we’re headed for a stock market crash. The crash levels of 2020 related to Coronavirus, when the stock market experienced the largest drop in almost a decade, with the Dow plunging almost 2,000 points — the biggest decline since the European debt crisis in August 2011, is still a fresh reminder.

While nobody can predict if and when the market will tank (or by how much), we all know that markets ebb and flow. Sometimes, they do so dramatically (especially when unexpected events — like a global pandemic — occur).

But a stock market crash is only bad news if you need your money soon — and you should never buy stocks with money you’ll need soon.

For most people that are playing the long game with their investments, a stock market crash should be a non-issue. Here’s why:

In the past few years, the S&P 500 has experienced significant drops, neither of which did any lasting damage. Over those years, however, the value of the S&P 500 has more than doubled.

That’s the good news, and also the bad.

The fact that the S&P 500 has done so well over the last several years (despite the occasional scary bump) is a reminder that stocks are still a great long-term investment. But stocks won’t climb at this rate forever.

How much a long-term stock market investor can expect to earn over 30 or 40 years is the subject of much debate. Historically, an average annual rate of return of 10% (not adjusted for inflation) over 30 years is not unusual. But we shouldn’t expect that will always be the case. This article does a good job explaining why.

Nothing

For long-term investors, the best thing to do when the stock market crashes is literally nothing. Sit tight.

Take a breath, turn off the news and — whatever you do — don’t log in to view your account balances.

Resist any urge to sell stocks

Selling stocks in a panic is the worst thing you could do after a stock market crash. Successful investing is about buying low and selling high. When you sell after a crash, you do just the opposite.

And if you think you can just cash out for now and then get back in when the market improves, consider this: you have no way of knowing when the market will swing back. And there is a big cost to missing just a few really good days in the stock market.

For example:

• If you invested $10,000 in the S&P 500 between 2002 and 2021 and left your money invested, you would end up with $61,685, a 9.5% annual compounded return.
• If you missed the 10 best days, you would end with just $28,260, a 5.3% return.
• If you missed the 20 best days, you’d have just $16,804, a 2.6% return.

These statistics are from a 2022 Guide to Retirement y JP Morgan Asset Management.

Buy stocks (if you were going to anyway)

The best time to buy investments is when you have money to invest. The best time to sell investments is when you need money for something else.

That said, if you’ve wanted to invest but have been dragging your feet for whatever reason, you might see the stock market crash as a buying opportunity. No, you don’t know if the market is going to go back up or continue to go down. But you do know this: stocks are about 10% cheaper than they were last week.

If you’re thinking of getting started with investing, check out our list of the best investment accounts for young investors.

Rebalance your portfolio after things have calmed down

Diversification is important for successful investing. Although I’m a fairly aggressive investor, bonds and real estate securities make up about 20% of my portfolio.

After a volatile period in the market, the value of your investments may change enough to shift your actual asset allocation away from your target. There’s no rush, but big movements in the stock market are a good reminder to give your portfolio a checkup and consider making some moves to bring your portfolio back into balance.

One resource I’m currently using for this is Wealthfront. I opened an account with Wealthfront because of some specific things they had that I really liked, like the 529 College Savings Plan. I also like their Wealthfront Cash Account, which has something called Self-Driving Money™. Essentially, you can automate any cash in your account to flow to different savings and investing accounts based on your pre-set savings goals. It makes saving and investing incredibly easy.

For unseasoned investors, drops can be especially terrifying. But, it’s also not the end of the world. When you’re young, you have years to make up for stock market drops — so Gen Z and Millennials should be the least concerned.

That being said, it’s still easy to react poorly when something this scary happens. That’s where potential value with robo-advisors comes in.

Robo-advisors don’t react out of fear like we do. Through complex algorithms, they choose the best stocks and bonds for you, which can be especially helpful (and offer a lot of peace of mind) when the market is in flux and you’re panicking.

Here’s a list of our favorite robo-advisors to get you started, but let me talk about some of my absolute favorites right now for this exact situation. 

First, Betterment is awesome. I just love their platform. They’re a robo-advisor that has a ton of features (including a new cash account and automatic tax-loss harvesting) and best of all, no minimum investment with a $10 min. deposit. So when the market is uncertain like it is right now, you can start investing with no minimum.

The other robo I am loving right now is M1. They have a lot of flexibility if you want some more control over your portfolio, but still want the ease of using a robo-advisor. TL;DR is that they’re affordable, super flexible, and you can invest in fractional shares.

Amid speculation that an impending recession could be on the horizon that would potentially impact your stock investments, you should remember that stocks are still an effective long-term investment.

Unless you need cash immediately (in which case, you probably shouldn’t have been in the stock market in the first place), do not sell off your stocks after a crash. The best thing to do is sit tight and have patience. If you have money to invest, buying stocks low could prove to be a savvy long term move during a recession. After things have cooled off, take time to review your investments and make any adjustments to bring your asset allocation back into balance.

Additional reporting by Juan Ruiz.