What can investors learn from a stock market crash?

On 19 October 1987, stock markets in Hong Kong and Asia began to fall. As the day progressed and other stock markets opened, the declines accelerated and spread: first to Europe, then the UK, then the US. By the close of trading, the FTSE All Share was down around 10%* and the Dow Jones Industrial Index in the US had fallen around 22%*. The losses were so bad the day was soon coined “Black Monday”.

So, three decades later, what can we learn from this market crash?

Six lessons to learn from market crashes

  • Don’t panic: if you sell, you are crystallising losses. If you hold, it may take a bit of time, but your investments should recover. Long-term investors are invariably better off ignoring short-term market movements – even the most dramatic!
  • Be brave: don’t try and time the market – it’s not possible. But consider investing when markets are falling – they may fall further to start with, but if you invest a little at a time you will benefit from pound cost averaging.
  • Reinvest dividends: if you are not reliant on the income, reinvest your dividends. The FTSE didn’t recover until May 1989 but, over the intervening 30 years, it has risen 247%** in price terms and 1,310%**, with dividends reinvested. This compounding effect is often referred to as the eight wonder of the world.
  • Think long term: market recoveries can take days, months or years. And different markets can react differently to the same crash. This is why we say investors need an absolute minimum of 3-5 years investment horizon – time enough (hopefully) for an investment to recover from a fall.
  • Good fund managers will pass the test: market crashes will test the process and the ‘mettle’ of the fund manager. How they react can be very telling. Can they stick to their process, ignore the noise and make the most of appropriate opportunities as they arise? Or do they freeze or do something out of character?
  • The smaller the losses, the smaller the gains required to recover: if the value of a fund falls less than markets and peers, it has less to do to recover. A lot of outperformance and ‘value-added’ can be achieved at such times. It’s why we prefer funds with investment styles that should mean they behave in just this way, so you’ll see a bias towards this in most of our fund suggestions.

Funds that can help protect against market crashes

Could it happen again? We’ve experienced two further stock market crashes in the intervening years – at the turn of the millennium when the dot.com bubble burst and in 2008 when the global financial crisis took hold. So yes, it could happen again. We’ve also experienced a number of smaller ‘corrections’ along the way.

There are a number of steps investors can take to protect their investments from market crashes. One example is by investing in a fund that can make money when stock prices fall as well as when they rise. F&C Real Estate Securities, Henderson UK Absolute Return, Jupiter Absolute Return, Smith & Williamson Enterprise and Threadneedle UK Extended Alpha are all Elite Rated funds with the flexibility to do this. There is no guarantee that they won’t fall at all, but they could help minimise the impact.

*Source: FE Analytics, 16 October 1987 to 19 October 1987 in local currency terms.
**Source: FE Analytics, 16 October 1987 to 11 October 2017

This article is provided for information only. The views of the author and any people quoted are their own and do not constitute financial advice. The content is not intended to be a personal recommendation to buy or sell any fund or trust, or to adopt a particular investment strategy. However, the knowledge that professional analysts have analysed a fund or trust in depth before assigning them a rating can be a valuable additional filter for anyone looking to make their own decisions. Past performance is not a reliable guide to future returns. Market and exchange-rate movements may cause the value of investments to go down as well as up. Yields will fluctuate and so income from investments is variable and not guaranteed. You may not get back the amount originally invested. Tax treatment depends of your individual circumstances and may be subject to change in the future. If you are unsure about the suitability of any investment you should seek professional advice. Whilst FundCalibre provides product information, guidance and fund research we cannot know which of these products or funds, if any, are suitable for your particular circumstances and must leave that judgement to you. Before you make any investment decision, make sure you’re comfortable and fully understand the risks. Further information can be found on Elite Rated funds by simply clicking on the name highlighted in the article.