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5 lessons from the Crash of 1987

Twenty-five years ago the stock market lost more than 20% of its value in just one day. Here's what we can learn from this.

By Stacy Johnson Nov 5, 2012 11:22AM

This post comes from Stacy Johnson at partner site Money Talks News.

 

Money Talks News logoWhile we're still living through the aftermath of what's become known as the Great Recession, we recently celebrated the 25th anniversary of something even more cataclysmic -- the stock market crash of Oct. 19, 1987. It's a day that changed my life forever, both professionally and as an investor.

 

Known as Black Monday, it's the day the market had its largest one-day percentage drop ever: more than 22%.

 

At the time, I was a stock broker. Watching the market meltdown that day was like watching a hurricane. It was terrifying, but at the same time awesome in its power.

And its aftermath actually altered my career path in a major way.

 

Image: Arrow Down (© Kyu Oh/Photodisc/Getty Images)When the market started melting down, local TV stations where I lived at the time -- Tucson, Ariz. -- sent reporters to the E.F. Hutton office where I worked. For reasons I no longer remember, I was chosen to represent the company and explain what was going on.

 

Over the course of a week, I was interviewed several times. Shortly thereafter, the local ABC affiliate offered me a gig on the morning news to talk about investing. About three years later, I quit my career as an investment adviser and founded Money Talks News.

 

So when I say the Crash of 1987 changed my life, I'm not exaggerating.

 

The crash also taught me important lessons that benefited me as an investor in subsequent difficult times. 

 

1. Always be in

When the Crash of 1987 occurred, I was all in. Every dime of available cash I had was in stocks. After the crash, I sold everything and was all out. Because I was both afraid and disillusioned, I stayed on the sidelines -- a dumb move since the market recovered its losses less than two years later.

 

If you're investing for the long term -- the only sensible way to invest -- you should always have some money in the market. Why? Because when you least expect it, the market will rise and you'll lose an opportunity.

 

2. Always be out

The lesson above suggests that no matter how bad the market looks you should always be in. But the opposite is also true: No matter how good it looks, you should also keep some powder dry because often, when the market looks like it can't go down, it's just about to.

 

Think of it this way: If everything looks rosy, everybody's in the market. If everybody's all in, there are no buyers left to push prices higher. Result? Stocks fall. So while it may seem counterintuitive, you should always have some money on the sidelines to take advantage of opportunities like market sell-offs.

 

3. Don't lose your head

The most difficult lesson to learn as an investor is that while markets certainly seem rational, they aren't. The reason is simple: Markets are influenced by people, and people operate on greed and fear much more often than they operate on logic.

 

This offers opportunity for those who can turn off CNBC, ignore the short term, and take the 30,000-foot view. Keep your head. Stay calm. Think it through. A cool head will allow you to see long-term gain when others can only focus on short-term pain.

 

4. Ignore the noise

The background of the market is noisy. "Experts" pretending they know the short- and long-term direction of the economy and the stock market fill the airwaves 24/7 with prognostications about something they can't possibly know -- the future.  They're not on the air to help you. They're often there to line their own pockets by pushing either themselves or a position in the market that will benefit them.

 

You should listen to informed opinions, but before investing you should always have your own. Listen, then decide. Let the firmness of your convictions determine your financial commitment.

 

5. Ask yourself two questions

If past is prologue, sooner or later the poop will always hit the propeller. It happened in 1987, it happened with the dot-com bubble, and it happened with the financial crisis of 2007-2008. The question isn't if it's going to happen again, it's when.

 

So the next time a crash occurs, ask yourself two questions:

  • Do I have money I won't need for at least five years? If the answer is no, then find another way to invest. Stocks may be too risky. 
  • Will things one day return to normal? In other words, is the world unraveling temporarily or permanently?  If the world's unraveling permanently, buy canned goods and guns. But if you think that eventually the problem du jour will be solved -- something that's happened since the dawn of man -- ignore those insisting the sky is falling and buy stocks.

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