Money Matters - Simplified

The Market Crashed -- Now What?

Because I write about the stock market, people often ask me when I think the market will crash next -- because there's always a next time, right? And though many financial prognosticators on TV seem to love predicting when the next big one will happen, my answer has always been the same, even when the market was doing well: "I don't know."

Let's face it: No one ever knows. There are so many influencing factors, the most anyone can do is guess. Of course, no one's asking me that these days, because it's still happening.

The Market Crashed -- Now What?Get original file (18KB)

But although I never know when the next market crash will happen, I know a little something about what happens after the market goes down.

It's happened before, after all
It's helpful, at times like these, to cast an eye backward and see what we can learn from previous crashes. Here's one assessment of the 10 worst stock market crashes in U.S. history -- and remember that this doesn't include the drops of 2008:

Began

Ended

DJIA Fell ...

Change

6/17/1901

11/9/1903

57 to 31

(46%)

1/19/1906

11/15/1907

75 to 39

(49%)

11/21/1916

12/19/1917

110 to 66

(40%)

11/3/1919

8/24/1921

120 to 64

(47%)

9/3/1929

11/13/1929

381 to 199

(48%)

4/17/1930

7/8/1932

294 to 41

(86%)

3/10/1937

3/31/1938

194 to 99

(49%)

9/12/1939

4/28/1942

156 to 93

(40%)

1/11/1973

12/6/1974

1,052 to 578

(45%)

1/15/2000

10/9/2002

11,793 to 7,286

(38%)

So let's compare that with what we've been experiencing:

  • On Monday, Sept. 29, 2008, the Dow dropped 778 points, the biggest single-day drop recorded at the time. That was around a 7% drop, but that's nothing next to 1987's drop of roughly 23% in a single day.
  • On Oct. 13, 2008, the Dow experienced its largest one-day point gain, when it rose by 976 points, or a whopping 11.1%.
  • Since its all-time high on Oct. 9, 2007, the Dow Jones Industrial Average has fallen by nearly 40%.

Holy volatility, Batman!

Where am I going with this?
Here are three key lessons we can learn from all of those ugly numbers.

  1. We can only know some things in hindsight. People focus on the crash of 1929, but although the Dow sat near 400 in 1929, it remained below 100 in 1942. One could argue that this was all one long crash, instead of several small ones. We won't be able to see the beginning or the end of a crash until it's long over.
  2. There aren't always clear causes. The 1987 crash, which featured a one-day drop of 23%, has many alleged causes, but there's no single, definitive, agreed-upon trigger. Irresponsible lending was a major precipitator of the crash we're in, but it wasn't the only one. Trying too hard to find the cause may blind us to an important truth: There will always be crashes.
  3. The market has always recovered. Although there were many significant crashes in the 20th century, the market trended up 10% a year, on average. So, although we may have to wait a while for a full market recovery, there's no reason to think it won't recover this time.

What should you do now?
Here are a few good rules of thumb for making it through a market crash.

  • Don't panic. Know that the market will always go up and down, sometimes sharply. Expect this to happen, and keep your cool when it does.
  • Don't invest any money in the stock market that you'll need within five years. As we've seen, the market can do anything in the short term. Having your son's college money in the market when he's a senior in high school, for example, could mean that his choices are much more limited if the market takes a steep decline.
  • If significant drops make your palms sweat, you can place stop-loss orders for your holdings with your broker. This can protect you, but it can also evict you from some great performers that slump temporarily.

But most of all, look for opportunities in crashes. According to many of our greatest investors, this is the time to buy stocks. As Shelby Davis once said, "You make most of your money in a bear market. You just don't know it at the time."

For example, on "Black Monday" in 1987, J.C. Penney stock fell 19%, from a split-adjusted $6.06 to $4.90. It gained that amount back within a few months, and within two years it had more than doubled. Look at Yahoo!'s chart, and you'll see that investors who bought after the recent Internet bubble burst have done all right, as have patientAkamai (Nasdaq: AKAM) investors.

So what might those opportunities look like? I suggest strong dividend payers -- stable growers that pay significant dividends no matter what the market is doing.

Colgate-Palmolive, for example, was essentially unaffected by the 2000 to 2002 market crash, as was Wells Fargo. And over the past decade, through market ups and downs, Colgate-Palmolive's dividend has grown by a compound average rate of 11%, and Wells Fargo's has grown by 14%. Some other high-yield companies worth a closer look are Dow Chemical (NYSE: DOW), Southern Copper (NYSE: PCU), PepsiCo (NYSE: PEP) and Philip Morris (NYSE: PM), which recently yielded 9.7%, 12.6%, 3.1%, and 5.6%, respectively. (Remember that some very high yields can be unsustainable, though.)

Dividend investing can save you from massive losses in many kinds of markets. If you're interested in adding some significant dividend payers to your portfolio, I invite you to try our Motley Fool Income Investor newsletter service free for 30 days. Its recommendations are beating the S&P 500 average, and those picks sport an average dividend yield of more than 6%. A free trial (with no obligation to subscribe) will give you full access to every past issue.

Copyright © 2008 Universal Press Syndicate.