A falling stock market is one of the most reliable tests of an investment plan. The plan that looks reasonable in calm conditions often does not survive the first 20% drawdown without revision, second-guessing, or outright abandonment. The historical data, however, are unusually clear on what works during a downturn: less activity, not more. According to a 2021 DALBAR Quantitative Analysis of Investor Behavior, the average equity fund investor earned 7.13% annually over the previous 20 years, while the S&P 500 returned 9.85% in the same period. The 2.72-percentage-point gap is not explained by fees or fund selection; it is explained by selling at the wrong time.
Is a market drop unusual?
No. Declines are a structural feature of equity markets, not an aberration. According to a 2022 analysis by Capital Group, the S&P 500 has experienced an average intra-year drop of 14% since 1980, yet finished the year with a positive total return in 32 of those 42 years. Drops of 10% or more, often called corrections, occur roughly once every 12 to 18 months. Drops of 20% or more, the conventional definition of a bear market, occur on average every six years.
The discomfort of a drop comes not from its rarity but from its visibility. A 10% decline in a $200,000 portfolio shows up as a $20,000 loss on a single screen. The same decline, spread over the lifetime of the portfolio’s underlying companies, would not draw a glance.
What does the historical recovery look like?
Markets have recovered from every drop in their modern history, though the time required varies widely. Data from S&P Dow Jones Indices show that the average bear market since 1929 has lasted 19 months from peak to trough and roughly 27 months from peak to full recovery. The 2007-2009 financial crisis took 49 months to fully recover; the 2020 pandemic drop took only five.
A more useful framing is rolling 20-year returns. According to research by Crestmont Research, every 20-year rolling period in the S&P 500 since 1900 has produced a positive total return after inflation. There has never been a 20-year window in which a diversified U.S. equity investor lost money in real terms. Investors who sold during downturns turned that statistic into a possibility for themselves.
Why is the urge to sell so strong?
The behavioral pull during a downturn is not a character flaw; it is a documented feature of human cognition. Loss aversion, formalized by psychologists Daniel Kahneman and Amos Tversky in 1979, means that the pain of a loss is roughly twice as intense as the pleasure of an equivalent gain. A 20% drop does not feel like the inverse of a 20% gain; it feels far worse.
Compounding this is recency bias, the tendency to extrapolate the most recent trend into the future. After a 15% decline, the implicit forecast becomes a further decline; after a 15% rally, the implicit forecast becomes a further rally. Markets do neither reliably, but the mind does.
The result is a pattern documented in repeated studies of mutual fund flows: net outflows accelerate near market bottoms and net inflows accelerate near market tops. Investors, in aggregate, buy high and sell low.
What should you actually do during a drop?
The actions supported by the evidence are surprisingly limited. The first is to continue any automatic contributions already in place. As covered in our piece on dollar-cost averaging, fixed contributions buy more shares when prices fall, which lowers the long-term average cost. Investors who paused 401(k) contributions during the 2008-2009 downturn took an average of 18 additional months to recover, according to Vanguard’s analysis of plan participant behavior.
The second is to rebalance, if the drawdown has materially shifted the portfolio’s allocation. A portfolio targeted at 70% stocks and 30% bonds may drift to 60% stocks and 40% bonds after a sharp equity decline. Rebalancing means selling some bonds and buying more stocks, which has the effect of buying low. The framework in our guide to building an investment portfolio from scratch covers target allocations in detail.
The third is to consider tax-loss harvesting in taxable accounts. Selling a position at a loss and immediately buying a similar but not identical security captures a tax deduction without changing market exposure. The IRS wash-sale rule prohibits buying the same security within 30 days, but a similar fund usually works.
What should you avoid doing?
The most damaging move is to sell to cash with the intention of buying back in once the market “stabilizes.” This requires being correct twice: once on the exit and once on the re-entry. A J.P. Morgan analysis of the S&P 500 from 2003 to 2022 found that missing just the 10 best days in the market over those 20 years cut the total return roughly in half, from 9.8% annualized to 5.6%. Six of those ten best days occurred within two weeks of the ten worst days. Investors who sell after a decline almost always miss the recovery.
Reading account statements daily is also counterproductive. Behavioral research by Shlomo Benartzi and Richard Thaler found that investors who checked their portfolios more frequently held less in stocks and earned lower returns, a phenomenon they termed “myopic loss aversion.” A quarterly review is sufficient for most long-term portfolios; daily monitoring is, at best, a source of anxiety.
Major changes to asset allocation during a downturn are usually mistakes. The time to decide whether the existing allocation is too risky is when markets are calm. Adjusting after a drop typically locks in losses at the worst possible moment.
Are there situations where selling is appropriate?
Yes, but they are usually unrelated to market conditions. If a goal’s time horizon has shortened, for example because a planned home purchase is now 18 months away rather than five years, shifting some equity exposure to bonds or cash is sensible regardless of where the market is. If an emergency fund is inadequate and the only available cash is in a brokerage account, selling to cover a near-term need is preferable to taking on high-interest debt.
What is not a reason to sell is the belief that one can time the next leg down. The evidence against successful market timing, accumulated over more than 50 years of academic research, is among the most robust findings in finance.
How should the next downturn be prepared for in advance?
The best time to plan for a market drop is when the market is rising. Three preparations matter most. The first is an emergency fund of three to six months of expenses held in cash, which removes any need to sell investments during a downturn. The second is an explicit asset allocation that matches both the time horizon and the genuine tolerance for volatility; an allocation that feels too aggressive during a calm market will feel intolerable during a falling one. The third is a written investment policy, even a single page, that records the plan in advance. During a drop, decisions made in advance carry far more weight than decisions made in the moment.
Frequently Asked Questions
Should I move my 401(k) to cash if a recession is predicted?
The evidence does not support reactive moves to cash, even when recessions are widely predicted. Markets often bottom before recessions are officially declared and recover before they end. According to Fidelity research, the average S&P 500 return in the 12 months following the start of a recession since 1950 has been positive. Long-term retirement portfolios generally fare better when left invested through the cycle.
How long does a typical bear market last?
The average bear market since 1929 has lasted about 19 months from peak to trough, according to S&P Dow Jones Indices, with full recovery taking roughly 27 months on average. The range is wide: the 2020 pandemic drop recovered in five months, while the 2000-2002 dot-com decline took more than seven years for the Nasdaq to recover. Bull markets that follow have historically been much longer than the bear markets that preceded them.
Is it a good idea to buy more during a market drop?
For investors with a long time horizon and an established plan, continuing or modestly increasing contributions during a drop has historically rewarded discipline. The strategy works best with broad index funds rather than individual stocks, because diversified indexes recover reliably while single companies sometimes do not. Adding new capital should never come at the expense of an emergency fund.
What is the difference between a correction and a bear market?
A correction is a decline of 10% to 20% from a recent peak. A bear market is a decline of more than 20%. Corrections are common, occurring roughly once every 12 to 18 months on average. Bear markets are rarer, occurring on average every six years. Both are recoverable; bear markets simply take longer.
Should I stop checking my account during a downturn?
For most investors, less frequent checking improves both returns and well-being. Quarterly reviews are sufficient for a properly diversified long-term portfolio. Daily monitoring increases the likelihood of reactive selling and, according to behavioral research, leads to more conservative allocations than the investor actually needs.
What if I am close to retirement during a market drop?
Investors within five years of retirement should already hold a more conservative allocation, typically 40% to 60% in bonds and cash, to cushion exactly this scenario. If the allocation was appropriate before the drop, the impact on retirement timing is usually smaller than it feels. Drawing first from the bond and cash portion during the recovery period preserves the equity portion for the rebound.
