How to overcome an irrational fear of share market crashes

With global share markets falling fast, yet again we have been reminded of the great bogeyman of markets – a crash.

Even though most of us only live long enough to see two or maybe three really significant and lasting market crashes, it remains such an outsized fear that you would think one happened every week.

Indeed, one of the more frustrating questions that I often hear about investing in the share market is “what about when the market crashes!”

The question comes most often from conservative investors who are desperately seeking confirmation that they are doing the right thing by avoiding what they perceive as an untenable risk.

Many are so focussed on the risk of capital losses that they adopt a much more conservative stance than they really should, leaving plenty of easy returns on the table.

In the most extreme cases, they invest entirely in cash both inside and outside superannuation, thereby ensuring that not only will they never experience a capital loss, they will never experience a capital gain either.

Usually, posing any opposing arguments about the average returns of the share market over time and the benefits of franked dividends is a waste of breath – such investors are terrified of market crashes and there is nothing that can be said that will change that view.

There is also no shortage of vested interests willing to promote fears of a market crash – annuity providers being one of the more obvious.

Even experienced investors can fall for crash mania

However, even those who are experienced share market investors can also fall into the trap of trying to time markets and preparing for a market crash that is “just around the corner.’’

The problem is that if that market crash doesn’t eventuate, how do you then make a judgement about when it is appropriate to put that cash back into the share market?

Buy back in and the chances are that dip you originally predicted might then arrive – continue to sit on the sidelines and the chances are the market could run away from you.

All of which further adds to fears of a crash or a large capital loss after buying back in.

Fear of a crash can be worse than the crash itself

The interesting thing is that it is the fear of a potential crash that forces a lot of this risk averse behaviour rather than a crash itself.

Indeed, for the properly prepared investor, a crash is often a long hoped for eventuality, like a sudden bargain basement sale that will give you a rare chance to set up your portfolio for more dramatic long-term growth.

That is not to say that buying into a crash feels great – it is very difficult to do, psychologically – but if you have some spare cash or borrowing capacity, it is almost always a fantastic move if you buy carefully.

Interestingly, one of the greatest investors of all time – Peter Lynch – put it best when he said that “more money is lost by investors trying to predict market crashes than in the actual crashes themselves”.

Lynch knows what he is talking about with his Fidelity Magellan Fund returning 29.2% a year between 1977 and 1990 and he has said that not missing out on the market’s strong days was another key to those high returns.

Particularly when markets are low or volatile it is easy to be caught sitting on the sidelines, waiting for some sort of signal to re-enter the market.

Missing a few strong days can be really costly

That is a time when you are particularly at risk of missing a few of those very strong days which can deliver high returns after being spooked into selling by scary headlines or gloomy predictions of imminent crashes.

The great thing about being a small retail or passive market investor is that you are ideally placed to profit from market volatility simply by not being intricately involved in the daily moves and the gossip and rumours that accompany them.

A recent example is the Australian market, with many investors warning of a big crash early this year.

From boom to correction in just a few days

Instead, the ASX 200 has confidently moved from under 7000 points in late 2023 to the record 8114.7 points achieved on August 1.

Since then, of course, there has been a dramatic downdraft in share prices and the ASX 200 has fallen sharply to around the 7700 level with all of the signs pointing to further volatility as the world adjusts to a stronger possibility of a hard landing and a recession as central banks move towards cutting official interest rates.

Where do we go from here?

It is really anybody’s guess but I would argue that the chances of the market rebounding from what is so far a sharp correction and nowhere near becoming a crash are greater than the market returning to the bad old days of the 1987 crash.

Selling into falls often a mistake

Selling into market falls is one of the reasons why many investors underperform the market index and failing to buy back in is another.

So, if investors shouldn’t get too worried about the chances of a market crash, what should they do when markets turn rocky?

Well, many experienced investors love market corrections and not just because they tend to be the pause that refreshes the market for a further upward run.

They keep some money outside the market and start to identify the many opportunities that always appear during a correction when valuations suddenly become more reasonable.

Even if you decide to do nothing and merely sit on the sidelines and hang on to your existing stocks, there is plenty of consolation around for when even a fair dinkum market crash arrives.

How long does a crash last?

Using some Fidelity analysis of market crashes, even waiting on the sidelines and looking sadly at your diminishing portfolio won’t last forever.

Looking at the Australian market, it took just 3 years and one month for the market to recover from the mammoth 1929 global crash.

The 1987 crash took longer at 5 years 8 months, while some of the other major market meltdowns were less enduring such as the 1997 Asian financial crisis (76 days), the 2001 9/11 terrorist attacks (36 days), the 2008 global financial crisis (5 years and 10 months) and the 2020 Covid pandemic (1 year and 1 month).

A crash can be serious or an opportunity

Even looking at the two more recent long-lasting crashes in 1987 and 2008, if you had largely sat on the sidelines and progressively invested along the way you would arguably have done much better than by progressively buying through the more common and longer lasting market bull runs.

It is true that a crash is a much more serious matter if you have borrowed heavily to invest or if you are a retiree with absolutely everything riding on the share market.

Even these examples, however, can be repaired through correct portfolio construction rather than by becoming totally allergic to share markets because of an irrational fear of a market crash.

In short, panic selling into a falling market is almost always a bad idea and worrying about a market crash and investing with an imminent potential crash in mind is also a bad idea.

A proper portfolio diversification across a variety of markets and sectors including fixed interest that accurately reflects your risk profile is a much better and more rewarding experience than hiding behind bushes terrified of an imminent market crash.