The thought of a stock market crash throws up all sorts of associations. From photos of traders looking stressed to dramatic graphs of plunging stock prices, a crash can seem like bad news.
But actually, for established investors as well as brand new ones, such an occasion can provide some promising opportunities. Here’s how.
What is a stock market crash?
Imagine that in your garden you have 10 apple trees. Six of them produce a fifth less apples this year than they did in the previous harvest. But four of the trees actually give you 20% more apples than before.
Is this a good or bad harvest?
Overall, the harvest is less than last year. But some individual trees have actually yielded a bumper crop.
I think of a stock market crash like that. The term typically means that the overall stock market has lost 20% of its value in a short period of time. The loss can be worse than that. Between 1929 and 1932, for example, the Dow Jones Industrial Average of leading US shares shed 89% of its value!
But that is an average. Not all shares do as badly during a market crash – and some may actually go up in value. Rather than owning an orchard, what if I could just choose the individual apple trees or shares I expect to do well?
Market timing and picking winners
Of course, while that may make sense in theory, can I manage it in practice?
Trying to time the market is very difficult, if not impossible – I do not bother to try. Instead, I focus on finding what I think are great businesses with enduring prospects.
I can think of some such businesses off the top of my head, from Guinness owner Diageo to Apple. The problem for me as an investor is that I am far from the only one trying to identify such companies. That can often mean that their share prices get pushed up to a level where they are not attractive to me. Even a great company can make a lousy investment if I pay too much for it.
A stock market crash might offer me the opportunity to buy the shares I want at a price I find attractive. If I was a new investor, I would see that as a great opportunity. I would not have made paper losses on an existing portfolio – and could hunt for bargains even among the ranks of quality companies.
The psychology of a stock market crash
As an investor with a existing portfolio, I also think that approach makes sense for me.
But seeing steep losses on one’s portfolio during a crash can be psychologically unsettling. If I do not sell, though, I have not actually lost money. If I bought shares in great companies to start with, I often ignore short-term price movements. Unless the investment case for a business has changed, I would hope its share price would reflect its quality in the long term even if there are bumps along the way.
That is why, just as I would if I was a new investor, I see a stock market crash as a buying opportunity for my portfolio.