How To Invest During A Stock Market Crash
Mr. Siwik

Mr. Siwik

How To Invest During A Stock Market Crash

The dumpster fire that was 2020 changed how I will invest forever. I learned two incredibly valuable lessons that pushed me to create my plan for how to invest in a stock market crash. A little bit of background before we jump into the my  plan for how to invest during a stock market crash.

Here’s how 2020 went for me as an investor: 

  • January 2020: I sold my house and wound up sitting on a bunch of cash. The market was making all time highs, so I thought  –  “I’ll wait for a pull back to invest this cash.”
  • End of February 2020: COVID is making front page news, investors are getting nervous and the market begins to pull back. Me – “Ok, I’ll invest a little cash, but save most of it for the big pull back”
  • March 9th 2020: DJIA drops nearly 8%. Me –  “This is a great buying opportunity, I’ll invest 10% of my available cash.”
  • March 12th 2020: DJIA drops another 10%. Me –  “I’ll put in a little more cash (maybe another 10%) but I’m getting crushed here. I know I should put more in because this could be the opportunity of a lifetime, but I’m getting seriously nervous.  Who knows how bad the pandemic could be, or how long this will last. On second thought, maybe I should hold on to my cash in case things get really bad.” Also me:

how to invest during a market crash

  • March 12th 2020: DJIA drops another 13%  – Me: 

investing during a market crash

  • August 2020: Market rebounds back to pre-crash levels – Me: 

How To Invest During A Stock Market Crash

  • December 2020: Market is making new highs – Me: “I’m a genius!” 

How To Invest During A Stock Market Crash

Once the dust settled, I started to reflect and ask myself two questions:

What did I learn from that? 

What will I do differently during the next pullback? 

So, what did I learn? Two things really:

  1. I froze…I’m a freezer. Fortunately, I didn’t “panic sell”, but I also didn’t have the guts to continue investing when the market was at it’s lowest. As a result, I may have missed the best investing opportunity in a decade. 
  2. I don’t like holding individual stocks. I didn’t lose any sleep watching my index funds plummet, but watching the individual stocks I picked get crushed was a different story.  It felt like I made bad picks. I know it’s not logical but I’ve learned that I don’t have the risk tolerance for picking individual stocks. I’m ok with that. Honestly, it’s probably a better strategy to not hold individual stocks. 

Now, the important questions. Why did I freeze? Easy, I didn’t have a plan! 

Ahh, hindsight. 

Lesson learned. Downturns are inevitable and I need to create a plan, ahead of time, for how to invest during the next downturn. That way, when things start to go sideways, I can remove the emotion, and just stick to the plan. Important note, this plan uses a long-term buy-and-hold approach to investing. This is for people that are saving for retirement or working towards financial independence. If that’s not you, no worries, but this plan probably won’t work for you.

Ok, let’s do it.

My plan for how to invest during a stock market crash 

 

My plan addresses three common questions:

  1. When to sell 
  2. When to buy
  3. What to Hold

First, when to sell. The answer, don’t. Simple enough, yeah? Long term investors should be prepared to ride the ups and downs. Selling in a market crash is the best way to get crushed. 

Next, when to buy. There are really two questions here:

    • How much cash should I hold in preparation for a downturn?
    • How and when do I deploy it?

How much cash (aka dry powder) should I hold? The short answer, none. Let me explain….

By chance, I had a lot of cash on hand during the last downturn. That’s not normally the case. In fact, it’s normally not good. Cash sitting on the sideline is just being eroded by inflation. So, you should always aim to put every dollar possible to work as soon as possible. Of course, there are exceptions. For example emergency funds, and short-term savings

The more I thought about it, holding cash back in order to  take advantage of market pull backs, is really just trying to time the market. There’s a ton of evidence showing that market timing doesn’t work. As they say, “time in the market beats market timing.” So why would anyone want to keep cash on the sidelines waiting for a pull back? For the same reason I was nervous to put cash in when stocks were getting pummeled.

Emotions….so many emotions.

investors during a market crash

Also, any guesses on who just learned how to add GIFs to their blog?

How To Invest During A Stock Market Crash

Ok, I’ll stop now.

But seriously, it’s so easy to let our emotions take over. We get scared or greedy overconfident and end up trying to time the market instead of trusting the math. Stockpiling cash and trying to time the market is a bad strategy and it doesn’t work…. unless you’re Warren Buffet

But what if there was a way to have the best of both worlds? To stay fully invested, get every dollar working for you, but when a pull back occurs, you can buy deeply discounted stocks. 

Fortunately, there is! It’s called rebalancing. 

Lets look at an example based on the crash of 2020

Let’s say we invested $100,000.00 on Jan 1, 2020. Our desired portfolio allocation is 50% stocks and 50% bonds, so $50,000 is put into a total stock market fund and $50,000 into a total bond market fund. 

By the end of March 2020, our stock fund lost 32% of its value. Our bond fund was also down, but only 5%. Here’s a snapshot:

    • Stocks – $33,928.00
    • Bonds – $47,664.00
    • Total – $81,592.00

Woof. 

At that point, our allocation looked like this:

    • Stocks – 42%
    • Bonds – 58%

So, we rebalanced. We sold $6868.00 of our bonds to get down to 50% and used the proceeds to buy stocks. At the end of 2020 both stock and bond prices recovered and our portfolio looked much better.

    • Stocks – $69,784.00
    • Bonds – $44,800.00
    • Total – $114,584.00

That’s a 14% return. Not bad! Remember, this is without investing any additional cash. As we established, long-term buy-and-hold investors should always strive to remain 100% invested. At that point, our allocation looked like this:

    • Stocks – 61%
    • Bonds – 39%

It’s was out of whack, but that’s expected. We just rebalance again.

You may be thinking, “what if we had pulled a “Mr. Siwik” and froze, doing nothing at all?” Well, let’s take a look. If we just rode out the year without doing anything, we’d wind up with a portfolio looking like this. 

    • Stocks – $58,035.00
    • Bonds – $52,337.00
    • Total – $110,372.00

That’s a $4,212.00 (nearly 4%) difference! So there you have it, the way to have your cake and eat it too. To stay fully invested and still buy discounted equities during a crash. (If you’re curious I used the prices for SWTSX and SCHZ at the beginning of 2020, the last week of March 2020 and end of 2020.)

A few tips for rebalancing: 

    1. Rebalancing in a tax deferred account will prevent you from having to pay capital gains taxes until you withdraw. 
    2. Avoid rebalancing too often. If you’re not careful you’ll eat into your gains with commissions and fees. Also, the more you tinker, the more chance there is to sabotage yourself (for example, selling and choosing to stay on the sidelines). 
    3. Instead, set up thresholds, and only rebalance when your asset allocation exceeds those thresholds. For example, if your desired allocation is more than 5% off, then you rebalance. I use google sheets to track my portfolio, and it’s easy to set up alert notifications when it’s time to rebalance. 

Ultimately, If you choose to ignore this, and hold on to cash. Or, like me, you accidentally wind up with a decent amount of cash right before a market dip. I strongly recommend you read themadfientist’s strategy for catching a falling knife. It’s the best method I’ve seen for removing emotion and systematically buying as the market declines. 

We’ve covered selling and buying, now for the third component of the plan, what to hold. Let me start by saying, I’m out on picking individual stocks.

how to invest during a market crash

For someone that blogs about money and personal finance, my goal is to think about my money as little as possible. More specifically, I don’t want spend energy worrying about my money.  

Ultimately, anything that causes me to spend too much of my time, energy and focus on money instead of my “why” has got to go. 

During the 2020 market crash, I figured out that for me, holding individual stocks had to go. I rarely checked the prices on my index funds. I didn’t get too worked up when they dropped 10% or more in a day. I know that I will hold them for the long-term, so they’ll bounce back. 

But I worried about my individual holdings. Would the companies I was holding go bankrupt? Would they ever bounce back? Should I get out when I get back to even? 

So, I decided to sell my individual holdings and move to a three fund portfolio. I chose a Total US Stock Market Index Fund, a Total International Stock Market Fund and a Total US Bond Market Fund (SWTSX, SCHZ, SCHF respectively). If you’re interested, I’ve written more on why I picked these funds and my specific allocation, here. But suffice to say I chose this three fund portfolio because it gives me:

  • Diversity – Three different asset classes gives my portfolio more stability and the ability to rebalance between assets classes. 
  • Simplicity – With just three funds, it’s super easy to track allocation and know when to rebalance. 
  • Strikes a balance between growth and risk tolerance – I’m still at an aggressive allocation of 90% stocks and 10% bonds, but I’m much more comfortable with index funds instead of individual stocks. 

 

Summary 

There’s my plan for how to invest during a stock market crash. 

  1. Don’t sell….period.
  2. Don’t stay on the sidelines (aka hold dry powder)
  3. Rebalance as needed
  4. Invest in a simple three fund portfolio and sleep soundly

What did you wish you knew…before now? What did you learn about yourself as an investor during the last stock market crash? Tell me in the comments!

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