A stock market crash is a rapid fall in stock prices that reduces the value of stock investments quickly. The result depends on what you own, how diversified your portfolio is, whether you use borrowed money, and when you need the money.
A diversified investor may face a large temporary decline. An investor concentrated in a few companies or using margin may face permanent losses or forced sales.
For example, a $10,000 portfolio that falls 30% is worth $7,000. It must gain about 42.9% to return to $10,000. A Federal Reserve note published on May 12, 2023, describes changes in asset prices before a sale as changes in wealth "on paper."
What Happens to Different Investments During a Stock Market Crash?
Different investments react differently during a stock market crash.
| Investment | Typical effect during a crash | Main risk |
|---|---|---|
| Individual stocks | Prices can fall sharply, and some companies may not recover | Permanent loss if the company fails or loses its competitive position |
| Stock index funds and ETFs | The fund usually falls as its underlying holdings fall | Broad market losses, although company-specific risk is lower |
| Bonds | High-quality bonds may provide some diversification, but their prices can also fall | Interest-rate risk, credit risk, and inflation |
| Cash and bank deposits | The balance generally does not move with stock prices | Inflation and the opportunity cost of staying out of the market |
| Retirement accounts | The balance may decline as the investments lose value | Selling during a downturn can lock in losses |
| Margin investments | Losses are magnified because the borrowed money remains owed | Margin calls and forced liquidation |
| Options and leveraged products | Losses can occur quickly and may exceed the initial investment in some strategies | Leverage, expiration, and forced trades |
Diversification can reduce the effect of a decline in one company, sector, or asset class. It cannot eliminate losses during a broad market sell-off.
Does a Stock Market Crash Mean You Have Permanently Lost Money?
Not necessarily. A market decline creates an unrealized loss when an investment is worth less than its purchase price. The loss becomes realized when you sell the investment for less than you paid.
Selling during a decline makes the loss permanent. Holding does not guarantee a recovery, though. A broad index fund, a financially strong company, and a failing individual company can have very different prospects after a crash.
The Federal Reserve has described unsold changes in asset prices as changes in wealth "on paper." The financial effect becomes more immediate when an investor must sell, especially while prices are falling.
How Does a Crash Affect Retirement Investments?
A crash can reduce the balance of a 401(k), IRA, pension investment account, or other retirement portfolio because these accounts often hold stocks or stock funds.
Someone with many years before retirement has more time to continue contributing and buy shares at lower prices. Dollar-cost averaging means investing equal amounts at regular intervals, whether prices are rising or falling. When prices are lower, the same contribution buys more shares.
The risk is greater for someone who is:
- Retired and withdrawing money from the portfolio
- Close to retirement and unable to wait for a recovery
- Forced to sell investments to cover living expenses
- Holding an overly aggressive or concentrated portfolio
- Relying on one company's shares or employer stock
Selling after a decline can create sequence-of-returns risk. This happens when large losses occur early in retirement while withdrawals are also being taken. Fewer shares remain to participate in a later recovery.
Can a Stock Market Crash Affect Bonds and Cash?
Yes. Cash, bank deposits, and some short-term government securities are generally less exposed to daily stock-price movements, but bonds can still lose value.
High-quality bonds may provide diversification. Their prices can fall when interest rates rise. Lower-quality corporate bonds can also decline when investors become more concerned about defaults and the economy.
Asset allocation means dividing investments among stocks, bonds, and cash. The right mix depends on an investor's goals, time horizon, and tolerance for losses.
A portfolio with 80% stocks will usually fall more in a stock crash than a portfolio with 50% stocks and 50% bonds or cash. The closer the spending date, the less practical it is to rely entirely on volatile investments.
Why Is Borrowing Money Especially Dangerous During a Crash?
Borrowing to invest can turn a temporary decline into a forced and permanent loss.
When investors buy stocks on margin, the brokerage firm lends them money and uses the securities as collateral. If the portfolio falls below the broker's maintenance requirement, the investor may receive a margin call. The broker may sell securities to cover the shortfall, sometimes without waiting for the investor's permission.
Margin can also cause an investor to lose more than the amount originally deposited because the loan still has to be repaid. Similar risks apply to leveraged exchange-traded products and some options strategies.
Does a Crash Affect Every Stock Equally?
No. Individual stocks can perform very differently during a market crash.
Companies with high debt, weak cash flow, expensive valuations, or heavy exposure to economically sensitive industries may fall more sharply. Defensive businesses, profitable companies, and firms with strong balance sheets may decline less. No stock is guaranteed to remain stable.
An index fund reduces the risk tied to one company because it owns a broad group of securities. It still carries market risk because the fund can fall when the overall market falls.
What Should Investors Do During a Stock Market Crash?
Investors should base their response on their financial position, time horizon, and investment plan.
- Check when the money is needed. Money required within the next few years should not depend entirely on a stock-market recovery.
- Review diversification. Check exposure to individual companies, sectors, countries, and asset classes.
- Avoid panic selling. Selling solely because prices have fallen can lock in losses and make it difficult to decide when to reinvest.
- Continue regular contributions if the plan remains suitable. Automated investing can purchase more shares when prices are lower.
- Rebalance according to the investment plan. Rebalancing can restore the intended mix of stocks, bonds, and cash after market movements.
- Reduce unnecessary leverage. Investors using margin should understand their maintenance requirements and the possibility of forced sales.
- Protect short-term spending needs. An emergency fund and a suitable cash allocation can reduce the chance of selling investments at depressed prices.
A stock market crash is most damaging when it coincides with high debt, forced selling, poor diversification, or an immediate need for cash.
The Bottom Line
A stock market crash exposes weaknesses in a portfolio, especially concentration, leverage, and insufficient cash for near-term spending. A diversified long-term portfolio may recover, but an individual company may not, and an investor who must sell cannot wait for a recovery.
The practical protections are a suitable stock-and-bond allocation, broad diversification, enough cash for near-term expenses, and avoiding borrowed money for investments.