Dramatic events can often lead to massive stock market gains or losses.
The media takes advantage of these big events and writes exciting or terrifying headlines.
Headlines generate excitement, fear and traffic for the websites.
However, these stories predicting a long term bull market, an impending correction or stock market crash should largely be ignored.
The problem is, I constantly see stories predicting the next market downturn. I bet you do, too.
Unfortunately, most people don’t stick to their investment plans. Instead, they eventually give in and listen to these crazy people.
People often sell their investments at the worst possible time.
Why? Because if you hear something enough, you begin to believe it is true.
So, why do these stories not matter? Why should you ignore them?
If The Stock Market Dropped 50% Tomorrow It Wouldn’t Affect My Strategy
If stocks plummeted tomorrow, it wouldn’t affect my strategy and it shouldn’t affect your strategy either. Why? Because you should have your investments set up in a way that matches your risk tolerance.
If you’d sell your investments when your portfolio goes down 50%, then your investments shouldn’t be 100% in stocks.
Think of it this way. If you had only 50% of your portfolio in stocks and stocks went down 50%, your total portfolio would only go down 25% if nothing else changed.
If you only had 10% of your portfolio in stocks, your total portfolio would only go down 5%. However, if you had 100% of your portfolio in stocks, your total portfolio would drop by the whole 50%.
You should have your investment portfolio set up so that you won’t likely experience losses that go beyond the pain point that would make you deviate from your investment strategy.
If you do this, then short term stock drops won’t matter. All that matters is the long run.
What The Stock Market Does In The Short Run Is Irrelevant
I’m a long term investor and my retirement is decades away. While no one can predict the future, history has shown that whenever stock prices go down as a whole, like with the S&P 500 index, they eventually recover over time.
Due to the fact I’m a long term investor, I have options short term investors don’t. Whenever stocks drop I look at it as an opportunity to buy more shares on sale because in the long run, stocks have always recovered.
Why would long term investors be scared of a drop in stock prices when in reality stocks are just on sale? In fact, I might even put more money in the stock market if it drops 50% in a short period of time.
Individual Stocks Could Ruin You
On the other hand, a cratering stock price could be a nightmare if you own individual stocks. Unlike the stock market as a whole, individual stocks do have the risk of dropping in price to nothing and becoming worthless.
Other stocks may not become worthless, but may never grow in value. However, if you diversify and own the broad stock market through an index fund, you don’t have the same risk.
While some stocks in the index fund may drop to nothing, others will increase beyond your wildest dream and they’ll average each other out over the long run.
Understand How The Stock Market Works As A Whole
While so many people get caught up in the emotion of the market, others look at historical data to get an idea of how the market works. While past performance is no guarantee of future results, it wouldn’t hurt to do some research yourself.
Did you know missing just the 10 largest single-day gains in the stock market over a 20 year period could result in a 3.68% lower annual return? It’s true.
Your Short Term Money Should Not Be In The Stock Market
The real reason why what the stock market does in the short run is irrelevant is the fact that you shouldn’t have your short term money invested in the stock market.
We do know that historically that the stock market can crash and a significant amount of wealth can disappear in a short time period. For that reason, never lock up money in the stock market you can’t afford to wait to withdraw.
If you keep enough money in cash or other less volatile assets to hold you over until the stock market recovers, it will be much easier to ride the roller coaster.
Since I already have my short term money, my emergency fund, I don’t have to worry about my long term investments. If they crash 50% tomorrow, I wouldn’t care and you shouldn’t either.
Have the right asset allocation and stick to your investment strategy. If you can do that, you’ll be doing much better than the average American investor.
It’s Possible We’ve Reached The End Of The World…
Finally, you may hear someone say something along the lines of “This time it’s different,” referring to a stock market decline.
If it’s true and this market decline eventually leads to the entire stock market declining in value until it is worthless, you might want to think of the actual consequences.
All of your investments in stocks would now be worthless, but what else would be happening? Chances are, the world will have gone crazy. Maybe we’ll be living in a nuclear holocaust or an asteroid destroyed life on Earth as we know it.
Regardless of why the stock market as a whole becomes worthless, money probably won’t be one of your biggest problems. Even cash will likely be worthless and chances are governments have collapsed, too.
Some would argue gold will have value because of its rarity, but I doubt it would. If people are trying to survive, they’re going to want things that help them survive. Gold has no use or value. It doesn’t feed you, hydrate you, cloth or shelter you.
That’s what will be needed.
Ultimately, I don’t think the stock market as a whole will ever reach zero. Thanks to inflation, it will continue going up over time for generations to come.
Could I be wrong? Yes, I could, but I wouldn’t want to consider why I’m wrong because it’d be a nightmare for all of us.
Do you freak out when the stock market crashes? Do you change your investment strategy? Or do you stick it out and wait for the markets to recover? I’d love to hear your real life experiences!
Lance Cothern, CPA holds a CPA license in Indiana. He’s a personal finance, debt and credit expert that writes professionally for top-tier publications including U.S. News & World Report, Forbes, Investopedia, Credit Karma, Business Insider and more.
Additionally, his expertise has been featured on Yahoo, MSN, USA Today, Reader’s Digest, The Huffington Post, Fast Company, Kiplinger, Reuters, CNBC and more.
Lance is the founder of Money Manifesto. He started writing about money and helping people solve their financial problems in 2012. You can read more about him and find links to his other work and media mentions here.