Can you handle a 30% stock market crash?

Life has been pretty busy this summer. We took a short trip to visit friends and family in California last month. We are back now, but life is still hectic because there are so many fun things to do in the summer. This year is busier than ever because RB40jr is also taking swimming lessons and learning how to ride a bike. Consequently, I haven’t paid much attention to the stock market. I noticed that our portfolio was down a bit in June when I did our monthly financial update, but I attributed that to the Greece financial crisis.

Then, I heard on the radio that the China’s stock market is crashing. That’s not good. My target asset allocation has 10% of emerging market so I should notice these big movements. Well, it looks like the China and Greece crisis affected our portfolio, but not that much. We have VWO and VEMAX (emerging market index funds) in our retirement funds and they declined about 15% from the high at the end of April. That translates to about 1.5% decline in our stock portfolio. The other sectors are up and down so our net worth didn’t decline much. In summary, the 30%-40% decline in the Chinese stock indexes didn’t affect us that much. It pretty amazing considering the China stock market lost over $3 trillion in value over the last 3 weeks and it’s probably not over yet. I’m glad our portfolio wasn’t impacted much, but it got me thinking – can we handle a 30% US stock market crash?

China’s Stock Market Crash Recap

Here is a quick recap of the China’s stock market crash for those of you who have been too busy this summer (our editor, Mrs. RB40 for one.)

  • China’s Shanghai Composite index lost $3.5 trillion in value from its peak on June 12th to July 9th.
  • Only 1.5% of the Chinese A shares are owned by foreigners. The Hong Kong listed H shares are down too, but less than the Shanghai market’s A shares. This limited foreign investors’ exposure to the crash. Whew!
  • The Chinese government has been trying to prop up the mainland stock market, but hasn’t had much success until late last week. Beijing has reduced the interest rate, limited short selling, suspended IPO offerings, banned sales by large shareholders for 6 months, loosened leverage policy, and extended credit to brokers to buy shares.
  • The rise of the stock market was fuel in part by huge margin financing (over $350 billion on margin). Basically, individual investors borrowed money to buy stocks. When the stock market crashed, investors had to sell to cover the margin calls. Many individual investors took out home equity loans and used peer to peer lending to fund their stock purchases.
  • Roughly half of the companies listed have pulled their shares out of the stock market to prevent further drops.
  • Stocks stopped trading when the share prices dropped more than 10%. This caps the drop to 10% per day, but you don’t know when it’s going to be over.
  • 30 million new trading accounts were added in the first 5 months of 2015. Everybody and their cabdrivers wanted a piece of the action.
  • The Shanghai Composite index increased 150% in value from June 2014 to June 2015, then dropped 30% since. Long time investors are still doing extremely well. The Shanghai composite index is up 85% compare to S&P 500’s 7% over the same period.

Can you handle a 30% stock market crash?

How we handled past stock market crashes

Okay, the news made the crash sound worse than it really is because they focused on the 30% drop. Long time investors have done extremely well and they don’t have anything to complain about. I don’t think this crash is played out, though. Let’s keep an eye on it and see how it goes over the next few weeks. The Shanghai composite index was up for the last 3 trading days, but I think it will resume dropping.

Back to my original question – what if the US stock market drops 30% in value? Would I panic and sell off stocks while the market is down? Let’s see what I have done in the past.

The dot com bubble in 2000

I started working in 1996 and invested in the stock market right away. At the height of the market, my net worth surpassed $100,000! That was huge for someone just a few years out of college. Unfortunately, I didn’t know much about the stock market and invested a large portion in Intel, my old employer. The stock hit $75 in August 2000, crashed, and went sideway since then. From this episode, I learned that I need to diversify. Also, I had to sell off some stocks when the market was down to cover the margin call. During the crash, I kept investing in my 401k, but stopped investing in my taxable account.

Lesson #1 – Don’t put all your eggs in one basket. Don’t invest too much money in your employer’s stock.

Lesson #2 – Don’t invest with borrowed money. I’m not smart enough to do that.

The global financial crisis in 2007

We were in a great financial position in 2007. We were both working and making good income. We didn’t have a kid, our monthly expense was reasonably low, and we didn’t have much debt. This time, our investments were more diversified and were not concentrated in one company or sector. However, we didn’t have much in bonds or other alternative asset classes. Our net worth declined about 25% during the worst of it, but we kept investing. I learned from the dot com crash that we should keep buying while the stock market was down.

Lesson #3 – Figure out your target asset allocation and stick to it. If you need help, read my asset allocation article and find a good financial advisor.

Lesson #4 – Keep investing through the bear markets, that’s when you build wealth.

The next stock market crash

The US stock market has been on the rise since early 2009. That’s a long time and we will see a stock market crash (10% drop within a few days) at some point. I have a feeling the next stock market crash will be more difficult for us than the previous two. I’m not working full time anymore so we won’t have as much money to throw at the stock market when it’s down. We can’t power though the next crash so we need to use a little more finesse. Our investment is much more diverse today and I’m pretty confident we will be able to handle the next crash. We have bonds, rental properties, REIT, foreign stocks, and cash. Our diversified portfolio should not drop as much as last time. Most importantly, I need to keep my head and don’t panic sell.

Lesson #5Start investing young so you go through a few stock market cycles with a stake in the game. This will help you figure out your risk tolerance and find your investing strategy.

Lesson #6 – Readers, do you have any tips for the next stock market crash? Should I hedge my bets with precious metals or invest in a hedge fund?

I love the stock market

The stock market is one of the greatest ways to generate wealth over time. I have been investing in the stock market for almost 20 years and it was very rewarding. I’m glad I started young because it took me a long time to evolve my investing strategy. Many Chinese cabdrivers are going to lose their shirts because they haven’t had time to become a mature investor.

Having gone through two crashes, I now have a solid strategy that I’m comfortable with. I’m not working full time anymore so I’m less aggressive and have more in alternative investments. A 30% drop in the US stock market should not cause a 30% drop in our net worth. Our net worth probably will drop 15-20% and I wouldn’t lose much sleep over that.

Do you think you can handle a 30% drop in the US stock market? Share you tips on how to handle the next stock market crash with us. 

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Joe started Retire by 40 in 2010 to figure out how to retire early. After 16 years of investing and saving, he achieved financial independence and retired at 38.

Passive income is the key to early retirement. This year, Joe is investing in commercial real estate with CrowdStreet. They have many projects across the USA so check them out!

Joe also highly recommends Personal Capital for DIY investors. They have many useful tools that will help you reach financial independence.

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35 thoughts on “Can you handle a 30% stock market crash?”

  1. Joe,
    One thing I would question about the premise is should you have to handle a 30% crash? I think many investors talk about just being long and don’t talk about being short or hedging. There are many strategies from running a long-short portfolio to buying puts to selling calls or selling OTM puts as strategies. Lots of ways to do it, but I think it deserves much more thought. You have to come back 2x to recover whatever you lose in a down draft.

    Reply
    • Thanks for your comment. I’m not a fan of being short, but I think hedging is a good strategy. I need to learn more about hedging, though. I will set aside some time to figure it out. I think options is probably the easiest way to do it.

      Reply
  2. I think this reinforces the notion of knowing what your investment time frame is – if it is 10 years or more you should buy and hold.

    I have seen a lot of writing about trying to time the market during various bull markets and corrections. It comes down to a couple days usually that if you missed being in our or out of the market, you have severely impacted your overall return. Who knows if, when, or how much the market will tank?

    If we let our emotions rule our investment choices we will be buying high and selling low. So this means if we are in the market it is because we a bullish about what the long term return will be with a buy and hold strategy.

    Reply
  3. We don’t have the goal of retiring early, so we can easily weather a 30% crash in the next two or three decades. But yes, market fluctuations underscore the need for a diversified portfolio, in the stock AND real estate market.

    Reply
  4. Lesson #4 about continued investments in the stock market even in the bear market is so interesting to me. I think it’s fascinating because our emotions yell at us not to do it, but it’s the right play to make, which is deeply complex.

    Reply
    • It’s easier when you have a good income. Now that we don’t have as much extra money coming in, it’s more scary. Everyone wants to hoard cash when the economy isn’t doing well.

      Reply
  5. Not only could I handle a 30% crash (or 40% or 50%), I’d welcome it. I think those of us with long term timelines and a DGI mentality learned a lot from the last crash and would be apt to deploy more funds. I unfortunately only started to learn about this a couple years ago and would have made a lot more sacrifices and changes if I knew then what I knew now.

    Reply
  6. “Do you think you can handle a 30% drop in the US stock market? Share you tips on how to handle the next stock market crash with us.”

    Yes, I can handle it. I have on three occasions: 1987, 1999, 2008 No problem. Though I will say the more dollars that deplete the scarier it gets. So how to handle it: I breathe, I ignore my investment tracking system, and I trust the process. Simpler said than done, but it is the only method that works for me. When I knew I had 30 years before I needed the money it was very easy. Now that I will need the money in ten or less it is just a matter of rebalancing to an appropriate risk strategy and trusting the process.

    Reply
  7. Money guru, Jane Bryant Quinn, has a lot to say about market crashes. She says to always have a couple of years of living expenses $ in liquid cash to ride the downfall out. Makes sense.

    Reply
  8. It seems like the best thing is to have everything in order-house, car, student loans, etc-established before going to stocks. It can be a wise idea to ensure that these are taken care of before the stock collapse or goes through a dip!

    Reply
  9. Those are good lessons, Joe. I have to say, while I’d be unhappy to see a 30% drop in stock values, it probably wouldn’t be a cause for panic since my time horizon is long-term at this point. We’ve seen how people panicked in the last stock drop, thinking the sky was falling, and selling low clearly hurt them big time. Ride it out, and see that bear markets can be great buying opportunities for long-term gain in many situations.

    Reply
    • At this point in my life, I wouldn’t be happy about a 30% drop either. It would be pretty nerve racking. Hopefully, I can stick to the game plan.

      Reply
  10. The last few crashes in the US stock markets turned out to be great buying opportunities because they were followed by snapback rallies. One day we may see something like what happened to the Nikkei 225, which has only recently climbed back to half its 1989 peak value (although perhaps adjusted for deflation things are not quite so bad). Would we still be loving it then?

    I keep a 50% stock allocation and live on less than 1% in annual withdrawal rate, so I think I can deal with a 30% stock market drop even if it doesn’t recover at all during my lifetime.

    The China situation is fascinating, I don’t think we’ve ever seen governments go all-in the way they are apparently willing to. If it works and their bubble reflates to a permanently high plateau, I think it would be pretty ironic how it takes a Communist government to make such a strong commitment to a stock market.

    Reply
    • You are right. I would hate a prolonged drop like that. It would be another lesson to put in the book.
      The Shanghai Composite is recovering quite well, but can it really last? They are propping up the market and there must be some consequences. We’ll see what happens next. The market can’t grow on momentum.

      Reply
  11. Hmm, a 30% drop in the US stock market would mean roughly a 15% drop in my net wealth. This would basically push my ER date by 1 or 2 years, which wouldn’t be a disaster, but psychologically hard to take.

    By the way, you say the Market will face a “correction” since it’s been going up since 2009. I seem to remember there was a 10% correction in October last year, so what are you calling a “correction” here?

    Reply
    • Thanks for the note. I will fix the “correction”. I meant a crash – a drop of 10% or more within a short period.

      Reply
  12. As a relatively young investor (32), I’d welcome a correction. I’m still in the asset accumulation phase and as Dylan as already mentioned, as long as the fundamentals of the companies haven’t changed, I’ll be buying. A 30% discount would be awesome! As a dividend investor, that means much higher yields on cost.

    Reply
  13. I could definitely take it. I’m still 10+ years away from financial independence. And in my career thus far every year comes more income, which means more savings as I don’t inflate my expenses with my increases in income. I’d welcome a small correction as I know I’ll be putting more dollars to work at lower cost. This would definitely be scarier for someone on the verge of FI though.

    Reply
    • You’re right. It’s really difficult to start off your retirement on those bad years. It could have permanent impact on your retirement portfolio. It’s a good idea to put off retirement until the market recovers, unfortunately there are bound to be a lot of layoffs during those downturn as well.

      Reply
  14. I kept investing in my 401K during the 2007 crash just because I was too busy dealing with reorganizations at work – that was a good thing, I think. Like Joe, I am sufficiently diversified in my portfolio, and I have sufficient cash for living expenses to ride out a 30% crash for at least 5 years and will probably put more cash into the stock market.

    Reply
    • Wow, 5 years worth of cash. That’s great! We don’t have that much cash reserve because I like to have my money invested. We have about 6 months of cash reserve, but we have income from various sources. When we have less income, I would definitely shore up our cash reserve.

      Reply
  15. I’d just let it ride and not worry about a 30% crash. Last week I watched a year’s worth of living expenses disappear in a day. Didn’t bother me or interrupt my vacation at all! Our financial plans don’t hinge on daily performance in the stock market. We have a few income streams to keep us afloat and a cash reserve to cover temporary down turns in the market.

    Reply
  16. I can handle a 30% drop in the stock market. Were investing pretty aggressively right now but we have many more years in front of us. Even if our portfolio dropped 30% I wouldn’t fret, I would just keep investing as much money as I could. Appreciate you sharing your 20 years of experience investing in the stock market.

    Reply
  17. I agree that the news is blowing the China market drop out of proportion. Yes, it is big news, but isn’t the end of the world. The other day when the NYSE had the software glitch, the one news channel reported on it like no one could trade all day and really acted as if investors should think twice about the stock market. I hate when they sensationalize things.

    As for if I am ready for a 30% drop, yes. I too have learned a lot since the last 2 drops. During the dot com drop I was in college so I wasn’t investing too much at the time. During the ’07 drop, I kept investing and really wish I would have invested more money. It was really the first time I had a decent amount of money in the market and it dropped like that. I now have 3x as much and while a drop would mean our net worth takes a hit, I would be buying all along because I know over the long-term the market will come back.

    Reply
    • Wow, 3x is a great! We are still young so we don’t mind taking a little hit temporarily. It’s good to go through a few cycles so you have the conviction to keep investing. Many people pull out and regret it.

      Reply
  18. Hi Joe, I’m 24. I’m not as invested as you, but given my young age and low income, I am doing what I can. I would love a 30% discount sometime soon, so long as the underlying fundamentals of the companies don’t change as well.

    Reply
  19. Yes, I can handle a a “30% drop in the US stock market.” Heck, I can even handle a 30% drop in the Canadian stock market, given that around 90 percent of my portfolio is in Canadian stocks.

    What’s more, I can handle a 30% or 50% drop in house prices due to a recession because I have always looked at a house as a consumer item and not as an investment.

    My motto now is, “Turn it into something good.” That’s what I did with my being fired from my Engineering job in 1980. In the same vein, during the last recession when my stocks went down substantially, I wrote an ebook called “101 Reasons to Love a Recession”, which you can download as a PDF here:

    http://www.real-success.ca/ebooks/101_Reasons_to_Love_a_Recession.pdf

    For the record, you can enjoy the ebook — or hate it — whether we are in a recession or not.

    Reply
  20. Hi joe,
    I’ve been following you the past year or two.
    I retired in December of last year @ 62. I certainly recall both of the last crashes as well. The DOT com hurt us ( husband and I) while we THOUGHT we were diversified in our 401ks we found that many of our mutual funds all had a ton of tech stocks. That was a hard lesson, I started really reading up on what was is the mutual funds offered. My husband didn’t pay attention to his which was hit the hardest. I had just done a rollover leaving my company so I was in better shape. Going forward I started investing myself in specific companies. I notice most mutual funds carry a large portion of Apple now.
    Last crash I purchased Slot of stock and did really well. My husband just sold all his stocks fearing another huge dip! I’m completely invested. At first I was upset but now I’m ok with that. He is 6 years older than me and doesn’t have 10 years to recoup since next her he will be forced to start taking mandatory distributions. So we are about 60/40 out of the market completely. So I think it’s really about your age. We will see!

    Reply
    • Thank you for bringing this up. The index funds follow the market capitalization. So Apple are a big part of everyone’s index funds. That’s one reason why I don’t buy Apple in my brokerage account. 60/40 is a great mix for you. I’m afraid of the next crash also, but I don’t want to stop investing. We have more than 20 years left so we should be able to recoup any losses. Our mix is 80/20 today.

      Reply

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