The market crash plan investors wish they'd built earlier

In the past 10 years, global stocks have dropped from peaks by over 10% four times before reaching new highs again. But that doesn't prevent inevitable nerves as we wonder if this time, the drop will be different and leave us out of pocket on the hard-earned cash we’ve invested for a prolonged period.  

Sometimes, this can make people pull their money out of the market in an effort to save their money from a crash, but this can just as easily backfire and mean that they miss the market recovery. The reality for most investors is that if the investment plan they had in place before a market drop was right for them then, it’s likely right for them during the drop as well.  

Does stress hurt or help our investment decisions?  

If you are deciding whether or not to pull your money out of the market during a severe drop, you are likely in a state of stress. This tends to have an impact on our decision-making skills. According to the Journal for Consumer Research, while people tend to take more risks when there is a strict time deadline on their decisions, they become more conservative with their risk-taking if there is time pressure without a strict deadline.  

This makes sense in the case of a market drop. Let’s say an investor, Sarah, has £50,000 invested, and it’s dropped to £45,000 over the past week. She’s feeling the time pressure of deciding if she should do something before the market falls more, but there’s no strict date that she needs to make the decision by. If Sarah follows the pattern of most people, it means she’s more likely to play it safe and pull some or all her money out of the market.  

No one likes to think about the worst-case scenario, but that often means when market falls happen, they are left to panic without a clear plan. This can mean you make decisions that you wouldn’t have with a clearer head. The good news is there’s an easy way to combat this: come up a market crash plan before it happens. And experience tells us, another market correction is likely to be around the corner at some point.  

Creating your crash plan

Every time you get on your airplane, the flight attendants will remind you to review the emergency information in the seatback pocket in front of you. Frequent flyers can probably recite the instructions by heart. But there’s a reason they do this (besides the legal one).  

By creating clear guidelines, it means much less chaos in the moment as people know exactly what they need to do. You can apply the same philosophy to making your market crash plan.  

Ryan Murphy, global head of behavioural insights for Morningstar, has been investigating this with his team recently and identifies being educated about volatility and creating a plan as some of the most useful strategies for when there is a bump in the market. “Uncertainty and volatility are irreducible features of investing,” Murphy says. “There is no way to avoid these things, and so that’s going to be part of the process. It’s worth reminding people that that’s normal.”

Start with the basics

An important part of knowing what to do in a market crash is understanding what your investments can withstand based on how long your money will be in the market. Investors may be keen to take less risk because they don’t want to lose money. But it’s important to also consider if the amount of risk you are taking lines up with the returns you want.  

For example, let’s say Sarah from earlier is investing in a pension that she doesn’t plan to access for another 40 years. This means she has a lot of recovery time if there was a drop in the market. So, the bigger risk for her may be reaching retirement with a smaller pension pot than she anticipated. For her, it may make more sense to up her risk level to enjoy larger returns, rather than opting for lower risk options for fear of a market crash.  

For investors that are in the market for a long time, just a few percentage points of difference in return can make a huge difference to your outcome. For example, if Sarah invested £20,000 in a fund that returned an average of 5% each year after fees, she’d end up with £147,168 after 40 years. But if she invested in a fund that returned an average 8% after fees each year instead, she’d end with £485,468 instead.  

For those that have shorter time horizons, the decision can be a bit more complicated. While what happened in the past is no guarantee of the future, it’s useful to see how long it took markets to recover in the past. Over the past 30 years, the FTSE All World has dropped more than 10% every few years. On average, it’s taken 683 days to recover, but there's a lot of variation within that figure. For example, it took seven years for the FTSE to reach a new peak after the global financial crisis, but it had mostly recovered by 2011, before the Eurozone debt crisis came into play.  

In recent crashes, the recovery period has been much shorter. But it’s important for investors to understand that this pattern isn’t guaranteed to continue.  

If your investment horizon feels likely to be much shorter than the potential recovery time from a market drop, it might be time to consider derisking. This avoids finding yourself in an uncomfortable situation later on, when you need the money, if markets have fallen.  

Name your criteria

It may feel a bit silly to do now, but many investors find that it helps them to write out their investment plan in the case of a market drop so they can reference it if they need to later on. For those that plan to be invested for the long term, this plan might be as simple as saying carry on as you are. For those that are taking an income from investments, or have a shorter horizon, you can lay out what your plan is for your assets if the market drops by a certain amount.  

For those taking some of their investments as income, a significant market drop could mean taking your income from a cash pile instead for a while. This means you aren’t siphoning money out of equity funds when they are down and gives them the chance to recover before you need to withdraw.

You may also see a market downturn as an opportunity. Some investors might have certain stocks that they would like to buy but see as too expensive at the moment. However, if that stock becomes more affordable in a market dip, and you still believe the value is there, it could present a buying opportunity. Having a list of these potential buys can help add a bit more positivity to a downturn. However, it’s worth noting that ‘buying the dip’ is extremely hard to do. Investors are typically better off having an idea in mind of the price they’d buy a stock for, rather than trying to anticipate if the market as a whole will go up or down in the future.  

Stick with it

Whatever your situation is, creating a specific plan can be key to making the decision with a clear head, rather than in the moment. Laying out certain criteria, such as if your investments drop by a specific amount, can help you create firm guidelines for when to leave your investments alone instead of operating under the constant stress of whether you should take action or not.  

The right plan is the plan that you would stick to across different market conditions. If you plan to invest money for the next few decades, chances are you will experience a lot of them. So, when the time comes and the market takes a tumble, all you need to do is follow the plan you’ve already created, even if that plan is to just sit on your hands.