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