Market crashes are an inevitable part of long-term investing, but they don't affect everyone equally. Some people comfortably weather the storm while others see a large chunk of their savings wiped out.
Oftentimes, the difference comes down to the investing decisions made before and during the crash. If you fall into any of the following groups, you probably ought to adjust your investing strategy as quickly as possible.
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1. People who don't diversify
Diversification insulates you against loss by placing your money into many baskets. If you put all your savings in one or two stocks and they tank, you'll lose a lot of money quickly. But it's unlikely that every investment will fall at the same time. Some, like bonds and gold, tend to do well when stocks are at their most volatile. Spreading your money among many investments minimizes your losses because when some of your stocks are down, you'll have other investments that are doing better than normal.
While it's smart to mix up the asset classes you invest in, you also need to ensure you're diversifying within a given asset class. For example, you don't want to invest exclusively in tech stocks. Though there are a lot of strong companies in this arena, if a new regulation or unforeseen issue crops up, it could affect the entire industry. Even if you have your money spread among several different tech stocks, you could still lose a lot of it in this scenario.
Invest in several sectors to reduce your risk of loss even further. Continuing our example from above, that could mean adding some financial stocks and industrial stocks to your portfolio so your money's not all in tech stocks. But try to stick to companies whose business models you understand. This helps you better understand how any moves a company makes will affect its share prices.
2. People with portfolios that don't match their risk tolerance
Your risk tolerance indicates how much variability you're comfortable handling in your investment portfolio. Risk tolerance is usually higher among younger workers and lower for older adults. That's because losing some of your retirement savings isn't as big of a deal when you're decades away from retirement as it is when you're about to quit your job.
Those with high risk tolerances usually invest more money in stocks because of their higher earning potential. As their risk tolerance declines, they gradually move money into bonds and other less volatile investments.
It's up to you to decide what level of risk you feel comfortable with, but a good rule of thumb for retirement savings is to invest 110 minus your age in stocks. So if you're 40, you'd keep 70% of your savings in stocks and 30% in bonds.
You need to remember to adjust your asset allocation periodically to keep up with your changing risk tolerance. Doing this is key to minimizing your losses in a market crash.
3. People who are prone to making emotional investing decisions
Even if you've diversified your investments and made sure they match up with your current risk tolerance, there's a good chance you'll lose some money in a market crash. It's pretty normal. But how you handle that loss can determine whether it's temporary or permanent.
Some people decide to sell off their investments in the hopes of preventing future losses, but what this really does is eliminate the possibility of recouping those losses when the stock market rebounds.
Often, the best thing to do in this scenario -- assuming you don't have either of the two problems above -- is to just wait it out. Avoid looking at your portfolio if doing so is stressful and trust that you've invested wisely.
If you routinely contribute money to your investment account, continue to do so on the same schedule as before. Buying when share prices are low could net you a sizable profit when they rise again later on.
Market crashes are an inevitable part of investing, so it's important to get comfortable with the idea. If you follow the steps above, you shouldn't have to worry about these crashes messing up your long-term plans.
