For most of the last century, the stock market has been the picture of resilience. It has had occasional bumps in the road and difficult stretches, but in general, it’s been a reliable and consistently growing economic indicator. It has survived.
But history has taught us that the stock market is volatile. Those of us who are old enough to remember the Great Depression know that at least once, it was extremely fragile. With the insane growth of the stock market — and recent examples of it pulling back — some wonder whether there’s a chance history will repeat itself in the worst way.
What happens if the stock market crashes? Will it result in losing money in the stock market? And what are the chances of it happening again soon?
What Happens When the Stock Market Crashes?
Whenever the stock market experiences a dramatic and significant loss of value in a relatively brief time frame, most analysts call it a “crash.” There’s no formal definition for this event, but most market watchers would consider a drop of more than 10% from the stock market’s 52-week high to be a crash.
To gauge loss of value, analysts refer to the major indexes that track the stock market. In the U.S., these include the Dow Jones Industrial Index, Nasdaq, and the S&P 500. Foreign indexes, like Nikkei in Japan, are also used. When one of these indexes drops by double digits, market watchers consider it to be a crash.
Oftentimes, when one U.S. index drops, the others will follow. And because the U.S. indexes are reliable drivers of the rest of the world’s economy, foreign indexes usually follow suit. Panic mode goes into full effect. It’s not pretty.
Notable Stock Market Crashes in History
How do you lose money in the stock market? It can happen quickly in a crash. The signals that a crash is coming haven’t always been apparent — in fact, they’re rarely picked up (if ever). Many of the factors that have led to stock market crashes were only understood in retrospect, years after they happened.
While the investor community is getting smarter about how to protect itself, the next stock market crash will likely be the result of something that few experts have accounted for. But the past may offer clues. Here are some of the most calamitous stock market crashes in U.S. history.
The 1907 Bankers Panic
The first modern-day stock crash occurred after a rather sloppy attempt by a mining magnate to corner the market in his family copper business. The story’s a long one, but when the scheme collapsed, the copper company’s prices dropped sharply and caused a run on the bank owned by the magnate’s brother.
The effect spread across the country. Financier J.P. Morgan arranged a plan to bail out the banks, so long-term damage was averted. The panic also resulted in the 1913 creation of the Federal Reserve, the USA’s central bank and chief financial regulator agency.
The Wall Street Crash of 1929
The worst economic disaster in world history followed a decade of great economic expansion. It was easier for private investors to buy stocks, often on credit. This sent share prices up to the point where they became overvalued — a prime example of a stock market “bubble.”
Professional and experienced investors started unloading their shares. Stock prices declined sharply and soon bottomed out completely. The stock market lost 85% of its value. Customers ran on banks to withdraw their money, which in turn made the banks insolvent.
Other factors played into the crash of 1929, including the Federal Reserve’s hiking of interest rates (spurred by the overconfidence of new investors) and trouble in the agricultural business. The crash was a precursor, if not a direct cause, of the devastating Great Depression that lasted a decade afterward.
“Black Monday” Crash of 1987
Growing pains of new technology were the biggest factors in the crash that resulted in a 20% decline in both the Dow Jones and S&P 500 in 1987. Wall Street had just begun to accommodate automated trading through computers. On October 19, 1987, a large wave of computer orders came through to liquidate holdings when stock prices got lower.
The automatic sell-off amplified and stop-loss orders avalanched. Share prices barreled downward. The algorithms also canceled all buying, so bid orders vanished. This catastrophe followed some smaller warnings about the market, specifically a slowing economy, inflation, and a few overvalued stocks. The robots, as is their wont, overreacted.
Dot-Com Bubble Burst of 2000
The internet went mainstream in the 1990s, creating a seismic shift in the worldwide economy. New e-commerce companies began to flood the landscape in the latter half of the decade, and speculative investors were only too happy to flush them with capital.
Unfortunately, not all these new companies’ business models were necessarily thought out, even as cash flowed into them at alarming volume and caused them to become overvalued. There weren’t yet enough online users to justify all the new businesses cropping up. The bubble finally burst in 2000, and the Nasdaq index began a steep decline that lasted until late 2002. Most dot-com companies went bust, and it took almost 13 years for the Nasdaq to get back to previous highs.
Subprime Mortgage Crisis of 2007-08
The spectacular crash in 2007 and 2008 sprang from a complicated chain of events. Home loan companies had been coming up with creative ways to help those with poor credit records and low savings become homeowners. They issued mortgage agreements with high interest and adjustable rates.
Many mortgagees couldn’t keep up with the strict terms and defaulted. Long-time, “too-big-to-fail” investment firms that had strong ties to the subprime mortgage market began to suffer heavy losses. The ripples hit the stock market in September 2008, when the Dow Jones plunged 499 points. Over the next month, it plummeted 3,600 more points. The country entered a steep recession that lasted a few years into the next decade.
COVID-19 Crash of 2020
And, of course, there was the most recent crash, caused by the worst global pandemic since the Spanish Flu. The stock markets declined sharply between February and April of 2020, with the Dow losing 37% in value between February 12 and March 23. Unemployment skyrocketed, businesses closed, and traditional commerce slowed to a creep as mandatory shutdowns were put in place.
In this case, financial institutions were prepared. A full-blown recession was averted, and although the economy is still recovering amid optimism that the shutdown is ending, the effects were relatively short-lived. Fingers crossed.
How Do You Lose Money in the Stock Market When It Crashes?
There’s no way to get around it: A stock market crash is terrifying. It’s a sign that the financial structures that we’ve depended on all our lives are in a state of crisis. The fears get aired and amplified by the media, panic snowballs, and investors may appear to all be fleeing for the exits. It’s scary.
But is it a death knell for civilization? Well… we’re still here. The stock market’s still here. Blue-chip companies have survived multiple downturns in the market. So the answer is no.
What happens to your money in a stock market crash? In all honesty, not as much as you may be fearing right now.
When your stock shares go down in price, they only decrease in value. That’s not quite the same as saying you lose hard-earned money. It simply means that the stocks you own aren’t worth as much on the market as they were a few days, weeks, or months ago.
The loss in value comes from other investors who are panicking and selling their shares to prevent additional losses. During a crash, this sell-off gets intense and seems to affect every commodity on the exchange.
You don’t actually lose anything until you sell shares that you own for a loss of your original investment. That’s when you lose money. But if you hang onto those shares, there’s every chance in the world they’ll regain their value. It may take time to get back up to the price you bought them for, but they very well may.
Now, of course, some stocks won’t make it back. Perhaps the crash will be fatal for some companies who can’t afford to lose investors. It makes sense to unload those that have no hope of re-emerging when the market returns to normal. An examination of the companies that don’t make it back will likely reveal factors that the company always had going against it.
Smart investors have clunkers every once in a while. But they also have the discernment to accept losses and evaluate them from a rational point of view. That’s going to happen during a stock market crash — just maybe a little more heavily than stable times.
If My Stock Goes Down Do I Owe Money?
What about the nightmare scenario when a stock market crash wipes out your original investment and never gets back to the price you purchased it for? What happens if the share price goes below zero? Do you owe money to the company’s creditors?
On paper, the answer might appear to be “yes.” But in reality, the answer is “no.”
No matter how terrible your company’s fortunes get, there are controls in place to keep the share price from ever going below zero. That’s the only way you’d conceivably owe money.
But even then, you won’t. Legislation prevents shareholders from burdening any liability whatsoever when a company goes under. Creditors cannot go after private shareholders at all — they can only go after the corporation itself. Neither you nor your credit record will be affected. You’ll just lose the value of your investment, which stinks, but that’s all.
How Does a Stock Market Crash Affect Me, and How Can I Protect Myself?
It’s always wise to assume that, at some point in your investment career, the stock market will crash. This is just preparing for the worst, which should always be a part of your game plan no matter how great times are.
Here are some tips for staying afloat when the financial markets seem on the verge of collapse:
Take Some Profits During Bull Markets
We’re always excited when we see shares in a company we’ve invested in increase in valuation for a long time. It becomes almost a personal thing to hang onto those shares. But occasionally, you may want to cash in on a stock that’s done tremendously well for a year or so. If their stock price seems to be flat-lining or only experiencing modest increases, consider selling some or all of your shares to take profits.
Consider Crash-Resistant Investments
Some investment vehicles are considered safe havens in stock market crashes. They’re not get-rich-quick vehicles, but they’re relatively safe to put part of your money in. These include US Treasury securities, bank-issued CDs, and annuities. If you fear headwinds turning against the stock market, consider protecting what you can in these types of investment strategies.
Diversify Your Portfolio
We say this all the time, but it’s always worth repeating: Spread your investment capital and asset allocation across different industries, investment vehicles, and holdings. Crashes don’t always affect all industries, and some manage to sustain or even thrive while other sectors have to recover. Mitigate your risk by diversifying.
Keep a Cool Head
The number-one driver of a stock market crash — mostly — is investor emotion. Whether it’s giddiness when times are good that causes overvaluing, or panic during the crash that sends prices southward, emotion is never something that should guide your decisions. Don’t freak out when the crash hits. Anticipate it if you can.
Consider buying certain commodities while prices are low during a crash — don’t feel guilty about taking advantage of the downturn. Keep doing analysis and making sound decisions based on reason.
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