Between 1929 and 1932, stock values dropped by 80 percent because of the crash of 1929. Stock market crashes can devastate economies and leave the stock in your portfolio worthless. Even diversifying your stocks may not protect you -- a crash typically drags down all sectors of the stock market, and it affects the rest of the economy. The 1929 crash contributed to the Great Depression, for instance.
If one person gets nervous about the market and sells her stock, someone else with more confidence usually snaps the shares up. When stock markets crash, that doesn't happen: Everyone's nervous, everyone wants to sell and nobody wants to buy. A crash can start with a few investors dumping stocks, then spiral outward: Other investors panic and decide to sell, too, prices plummet faster, and that makes more investors try to sell. By the time the spiral stops, stocks may be worth a fraction of their previous value.
When the stock market crashes, a lot of people feel the pain. Companies can no longer raise as much money selling stock and may have to cut back on growth and expansion. Business leaders become cautious, which slows the economy and increases unemployment. Crashes hit particularly hard on anyone entering or approaching retirement, as the contents of 401k and other retirement plans may be worth less than the money the retiree originally put into the plan.
On a personal level, many investors become skittish after a crash. If an investor sees how her portfolio has plummeted in value, she may decide to pull out of stocks and concentrate on safer, lower-risk investments. A study of the 2008 stock market crash in the "Journal of Applied Econometrics" found, however, that stockholders were, on average, more confident after the crash than people who didn't own any stocks. Individuals who followed the stock market, whether or not they owned stocks, were also more optimistic, on average.
The Long Term
If you don't have to sell your stocks immediately, a stock market crash doesn't have to become a personal disaster. The market has crashed many times, but eventually investors start buying and stock prices rise again. If you have the stomach to just hang on, sitting out a crash without tinkering with your portfolio may minimize your losses. If you decide to keep investing, make cautious moves: Don't overextend yourself, avoid risk and cut your losses quickly if you make a mistake.
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