What to Do When the Stock Market Crashes (And What Not to Do)
- Mark Fonville, CFP®
- 6 days ago
- 16 min read
If the S&P 500 dropped 20% tomorrow morning, exactly how many months could you pay your mortgage without selling a single share of stock?
Most retirement advice assumes you have time to wait for the market to recover. But if you are retired or within five years of retiring, you don’t have the luxury of time—you have bills to pay today.
The standard advice to “buy and hold” works perfectly for a 40-year-old executive accumulating wealth. It can be mathematically challenging for a 62-year-old tapping that wealth for income.
This is the difference between an asset problem and a cash flow problem.
Key Takeaways
The “Fragile Decade” is critical: A market crash occurring 5 years before or after retirement is not a loss of value—it is a loss of time that can permanently reduce your sustainable income.
Stop “Reverse Dollar Cost Averaging”: Selling stocks during a downturn to pay bills cannibalizes your portfolio.
You need a “Cash Bridge” of 18–24 months of living expenses to [help] ride out volatility without selling shares.
Rebalance into the drop: A crash may shift your allocation away from target. Selling bonds to buy discounted equities restores your plan—this is discipline, not market timing.
Diversify while the tax cost is low: A downturn compresses embedded capital gains on concentrated positions, potentially reducing the tax hit of diversifying.
Harvest losses strategically: Tax-loss harvesting during a crash can generate capital losses that offset future gains, but be aware of wash sale rules and cost basis implications.
State taxes punish panic: Some states tax capital gains as ordinary income (up to 5.75% in Virginia and 13.3% in California) and cap loss deductions at $3,000.
Bonds targeting the “Agg” are not a perfect shield: As 2022 proved, bonds can fall alongside stocks. Your safety net should be built on true liquidity (cash, money markets, short-term and high-quality bonds), not just total bond market funds.
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Introduction
When the market crashes, the question isn’t “how much did I lose?” The right question is: “Do I have to sell anything to live?”
If the answer is no, the crash may be irrelevant to your standard of living. If the answer is yes, you are walking into a trap called Sequence of Returns Risk—the danger that early losses in retirement, combined with ongoing withdrawals, permanently impair a portfolio’s ability to recover.
(For a deeper look, see our guide on how sequence of return risk impacts your retirement.)
At Covenant Wealth Advisors, we believe that managing a crashing market requires more than generic platitudes about patience. It requires cash flow planning.
Why Is a Stock Market Crash Different for Retirees?
For retirees, a market crash is generally not a loss of paper value—it is a permanent destruction of future income potential.
Selling assets in a down market to fund living expenses is “Reverse Dollar Cost Averaging,” forcing you to sell more shares to generate the same cash, depleting your portfolio faster than it can recover.
In your working years, a market crash is essentially a sale. You are buying shares cheap with your 401(k) contributions. This is Dollar Cost Averaging working in your favor.
In retirement, the math flips. In a hypothetical scenario where your portfolio drops 20% and you need $10,000 a month to live, you are forced to sell more shares at a lower price to get that cash. You are cannibalizing the very engine that produces your future income.
We call the period five years before and after retirement the “Fragile Decade.” A crash during this window is uniquely dangerous because the portfolio has no time to recover before you start withdrawing from it.
The Math of Recovery
Consider the math of loss. It is asymmetrical. If you lose 50% of your money, you don’t need a 50% gain to get back even—you need a 100% gain.
Lose 10% → Need 11% gain to recover.
Lose 20% → Need 25% gain to recover.
Lose 50% → Need 100% gain to recover.
If you are taking withdrawals during that drop, the hole gets deeper. You might need a 150% or 200% market rally just to get back to where you started.
History shows us that “average” returns matter less; the sequence of those returns determines whether you run out of money at age 75 or age 95.
Hypothetical examples are for illustrative purposes only and do not represent actual client experiences.
What Is the Best Thing to Do When the Stock Market Crashes?
A critical first line of defense is a “Cash Bridge”: maintaining 18–24 months of living expenses in highly liquid, stable assets like money markets or short-term Treasuries.
This creates a buffer that helps allow you to stop selling stocks completely during a crash and live off your reserves until the market recovers.
However, it is important to note that maintaining large cash reserves may result in “cash drag,” potentially lowering overall portfolio returns during bull markets.
At Covenant Wealth Advisors, we do not believe in “timing the market.” We believe in cash flow planning and focusing on what you can control. (For more on why, see our analysis of whether market timing works.)
We often use a metaphor with our clients: Selling stocks in a crash to pay your electric bill is like burning your antique furniture to heat your house. It solves the immediate problem (the cold), but you have permanently destroyed a valuable asset to satisfy a temporary need.
The “Cash Bridge” (or War Chest) is the pile of firewood out back. You use that instead.
If you are wondering how much cash retirees should have on hand, we have written about that separately.
How the Cash Bridge Works in Practice
Let’s look at a hypothetical scenario for educational purposes for a couple in Reston VA, the Carters (age 64).
Portfolio: $3 Million
Income Need: $10,000/month ($120k/year) from the portfolio.
The Crash: The market drops 20%.
The Panic Move: The Carters continue selling stocks to get their $10,000 monthly check. Because prices are down, they have to sell 25% more shares every month just to pay the bills. When the market eventually recovers two years later, their portfolio is permanently smaller because they own fewer shares.
The Covenant Move: The Carters have a “War Chest” of $240,000 (2 years of expenses) in short-term, high-quality bonds or cash. When the market drops, we advise them to turn off the equity tap. They stop selling stocks entirely. For the next 18 months, they live solely out of the War Chest.
They have a small likelihood of selling shares at a loss. They simply wait. Should the market recover, historically taking 2.5 years on average, their share count is intact, and they participate fully in the rebound. Once the recovery is confirmed, we refill the War Chest for the next cycle.
“The goal isn’t to predict the crash. The goal is to make the crash irrelevant to your standard of living. If you have two years of cash, you can ignore the S&P 500 for two years. That is true financial freedom.” — Megan Waters, CFP®
But the Cash Bridge is not the only tool available during a downturn. A crash also creates specific opportunities to strengthen your portfolio’s tax efficiency and long-term positioning—if you act with discipline rather than emotion.
Rebalance Into the Drop
Your Cash Bridge buys you time. But a crash also creates an opportunity to improve your portfolio’s long-term positioning through rebalancing—the disciplined process of selling what has held up (typically bonds or cash equivalents) to buy what has fallen (typically equities), restoring your portfolio to its target allocation.
Here is why this matters mechanically. Suppose your target allocation is 60% stocks and 40% bonds. After a 25% equity decline, your portfolio might drift to roughly 50% stocks and 50% bonds.
Without action, you are now more conservatively positioned than your plan calls for—right at the moment when equity prices are lowest and future expected returns are highest.
Rebalancing is not market timing. It is the opposite. You are not making a prediction about what stocks will do next quarter. You are enforcing a rule you set in advance: maintain the allocation that matches your income plan and risk capacity.
(For more on the mechanics, see our guide on how often you should rebalance your portfolio.)
That said, rebalancing requires judgment, not just math. If your bonds are also down (as they were in 2022), selling them to buy stocks may not be appropriate. And rebalancing too aggressively—shifting well beyond your target into equities—crosses the line from discipline into speculation.
The goal is restoration to plan, not a leveraged bet on recovery.
[A financial advisor can help determine whether rebalancing is appropriate given your specific situation and risk tolerance.]
Diversify While the Tax Cost Is Low
A market decline can also be a strategic window to diversify concentrated positions at a reduced tax cost.
If you have been holding a large position in a single stock or sector—perhaps company stock from your career, or a legacy holding you have been reluctant to sell—a downturn compresses the embedded capital gain, which means less tax when you sell.
Consider a hypothetical example. You hold $500,000 in a single stock with a $200,000 cost basis. In a normal market, selling triggers a $300,000 capital gain.
But after a 30% decline, that same position is worth roughly $350,000—and selling now generates only a $150,000 gain.
You have cut your taxable event in half while moving into a more diversified allocation that may better serve your long-term income needs.
[This is a hypothetical example for educational purposes only. Actual tax consequences depend on individual circumstances, holding periods, and applicable tax rates.]
The math works in reverse too: if the position has fallen below your cost basis, you can sell, harvest the loss (more on that below), and redeploy into a diversified portfolio—effectively getting paid by the tax code to reduce concentration risk.
This strategy requires careful coordination between investment management and tax planning. Wash sale rules, state tax treatment, and the interaction with other income sources all matter.
But for clients sitting on concentrated positions, a market drop can turn a tax problem into a tax opportunity.
[Tax laws are subject to change, and individual circumstances vary. Consult a qualified tax professional before implementing any tax strategy.]
Harvest Losses to Offset Future Gains
Tax-loss harvesting is the practice of selling investments that have declined below their purchase price to realize a capital loss, which can then be used to offset capital gains elsewhere in your portfolio—or up to $3,000 per year against ordinary income under IRC § 1211.
(For a comprehensive overview, see our guide on how tax-loss harvesting works.)
During a crash, the harvesting opportunities multiply. You might sell a broad market index fund at a loss, immediately purchase a similar (but not “substantially identical”) fund to maintain your market exposure, and bank that realized loss for future use.
Your portfolio stays invested. Your allocation barely changes. But you now hold a tax asset that can offset gains for years—or decades—to come.
The key constraint is the wash sale rule (IRC § 1091), which disallows a loss deduction if you repurchase a “substantially identical” security within 30 days before or after the sale.
This means you cannot sell the S&P 500 index fund at a loss and buy it right back. But you can sell one large-cap index fund and buy a different one that tracks a similar but distinct index—maintaining your equity exposure while staying on the right side of the rule.
For retirees already drawing income, harvested losses are particularly valuable. They can offset the capital gains generated by portfolio withdrawals, rebalancing trades, or the sale of concentrated positions—reducing your tax bill in years when you are already managing income carefully.
Harvested losses can also help manage adjusted gross income, which in turn affects Medicare IRMAA surcharges and the taxation of Social Security benefits.
One important caveat: tax-loss harvesting reduces your cost basis in the replacement investment, which means you are deferring the tax—not eliminating it.
The strategy is most valuable when you expect to be in a lower tax bracket in future years, or when you can use losses to offset specific high-gain events. It is a planning tool, not a free lunch.
[Tax-loss harvesting involves risks including the potential for increased tax liability in future years. Consult a qualified tax professional.]
The “Recovery Gap”: Why The Total Bond Market Is No Longer the Perfect Shield
For decades, the standard advice was to hold a portfolio that represented the U.S. Aggregate Bond Index to cushion the blow of stock market crashes.
But the 2022 inflation shock proved that bonds don’t always work when you need them most.
Historically, a “60/40 portfolio” (60% stocks, 40% bonds) recovered much faster than an all-stock portfolio. But 2022 changed the calculus.
When inflation spiked and interest rates rose, both stocks and bonds fell together. The “safe” portion of many portfolios failed to provide the liquidity retirees needed.
Table: The Shrinking Safety Net
This table shows how long it took for portfolios to break even after major market crises. Note how the gap between risky and safe portfolios disappeared in 2022.
Crisis | S&P 500 Drawdown | Breakeven (100% Equity) | Breakeven (60/40) | What Happened? |
Dot-Com (2000) | -49% | ~7.5 Years | ~2.5 Years | Bonds worked perfectly. The “safe” portfolio recovered 5 years faster. |
Great Recession (2008) | -57% | ~5.5 Years | ~3.5 Years | Bonds worked well. Diversification saved retirees 2 years of stress. |
Inflation Shock (2022) | -25% | ~24 Months | ~21-24 Months | Bonds FAILED. The “safe” portfolio took just as long to recover as stocks. |
Source: Morningstar Direct / Vanguard Historical Data / Wealth of Common Sense. Past performance is not indicative of future results. Indices are unmanaged and cannot be invested in directly. Note on Indices: For the purposes of this comparison, “100% Equity” is represented by the S&P 500 Index. The “60/40 Portfolio” is a hypothetical allocation consisting of 60% S&P 500 Index and 40% Bloomberg U.S. Aggregate Bond Index, rebalanced annually. See footer for full index definitions.
Key Takeaway: In the recent 2022 crisis, bonds did not provide the quick recovery they offered in 2008.
This reinforces the need for a dedicated Cash Bridge composed of instruments that are not correlated to interest rate spikes—like Short-Term T-Bills or Money Markets—rather than just intermediate bond funds.
The “Triple Threat” to Your Retirement Portfolio
Panic-selling during a crash isn’t just an investment mistake; for many residents, it is a tax disaster.
Some state tax laws are particularly unforgiving when it comes to realized losses. If you get scared when the market drops and move to cash, you trigger three distinct financial penalties that can haunt you for decades.
1. The Income Tax Trap
Several states, like Virginia, treat capital gains as ordinary income. Unlike the federal government, which offers favorable rates for long-term capital gains (0%, 15%, or 20%), Virginia taxes your gains at your marginal income tax rate, up to 5.75%
There is no state-level reward for holding assets longer than a year. Panic selling appreciated assets to move to cash triggers a taxable event that the state treats the same as wage income.
(For strategies specific to Virginia residents, see our guide on how to reduce Virginia income tax.)
2. The 34-Year Deduction Penalty
This is the most painful trap for retirees. If you panic-sell a $3 million portfolio during a 10% correction and lock in a $100,000 loss, you might think, “At least I can write this off against my taxes.”
Not really. Federal tax law (IRC § 1211) limits your net capital loss deduction to just $3,000 per year against ordinary income.
The Math: To fully deduct a $100,000 loss at $3,000 per year, it would take you 34 years.
The Reality: Most retirees do not have 34 years to wait for a tax benefit.
You have permanently destroyed capital for a deduction you may never fully use. While you can use losses to offset future realized gains, you won’t receive an immediate deduction.
3. The Prudent Investor Risk
If you are a trustee managing money for a spouse or family trust, panic selling can actually create legal liability.
Under the Virginia Uniform Prudent Investor Act (§ 64.2-781), a trustee has a duty to manage risk and act prudently. Selling low and locking in losses out of fear could be considered a breach of that duty.
A beneficiary could theoretically sue a trustee for failing to manage inflation risk by moving entirely to cash at the bottom of a cycle. A defined strategy like the War Chest helps demonstrate prudence.
“A lot of clients come to us having done some version of planning on their own. The numbers look fine—until you factor in the tax torpedo that hits when you panic-sell, or the fact that Virginia only allows a $3,000 capital loss deduction. The details matter enormously at this level of wealth.” — Scott Hurt, CFP®, CPA
What Not to Do During a Stock Market Crash?
Do not stop contributions to retirement accounts, do not check your balances daily, and do not attempt to “time the bottom.”
Missing the best 10 days of the market recovery can cut your long-term returns by nearly half.
1. Do Not Stop Investing (if you are still working)
If you are in the “Fragile Decade” but still earning an income, a market crash can be an opportunity. It is a “fire sale” on the assets that will fund your future.
Stopping 401(k) contributions during a downturn is one of the most costly mistakes a pre-retiree can make. You are walking away from cheaper shares that would lower your average cost basis.
2. Do Not Check Your Balance Daily
This sounds like behavioral fluff, but it is a biological fact. Research suggests that the pain of financial loss is processed in the same part of the brain as physical pain.
Checking your balance daily can trigger stress responses that impair decision-making and lead to impulsive actions—like selling at the bottom.
3. Do Not Try to “Time the Bottom”
The stock market usually recovers before the economy does. By the time the news looks “good” again (unemployment down, GDP up), the market has usually already rallied.
If you wait for the “all clear” signal, you have already missed the recovery.
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Frequently Asked Questions
What Is the Best Thing to Do When the Stock Market Crashes?
The most effective immediate action is usually nothing regarding your core equity holdings, provided you have a liquidity plan.
Do not sell. Do not check your balance daily. If you have a “War Chest” (cash reserve) in place, switch your spending to that cash source so you don’t have to sell equities at a loss.
If you have extra cash on the sidelines, a crash may be a strategic opportunity to rebalance by buying depressed assets at a discount.
Should I Rebalance My Portfolio During a Crash?
Rebalancing during a downturn—selling bonds or cash to buy equities back to your target allocation—can be a disciplined move, not a speculative one.
However, it depends on whether your fixed-income holdings have also declined, how close you are to needing withdrawals, and whether your overall financial plan supports the shift.
Rebalancing works when it restores a predetermined allocation, not when it chases a bottom.
What Is Tax-Loss Harvesting and Does It Help During a Downturn?
Tax-loss harvesting involves selling investments at a loss to offset capital gains or up to $3,000 per year in ordinary income.
During a crash, more positions are likely to be underwater, creating more harvesting opportunities.
The key constraint is the wash sale rule, which prevents you from repurchasing a “substantially identical” security within 30 days.
This is a tax deferral strategy, not tax elimination—your cost basis in the replacement investment will be lower.
What Is the 3-5-7 Rule in Stocks?
The “3-5-7 rule” is a risk management guideline used primarily by day traders, suggesting one should risk no more than 3% of capital on a single trade, 5% on open positions, and target a 7% cap on total portfolio risk.
We strongly advise retirees to ignore this. Retirement planning is about long-term planning, not short-term trading rules.
Trying to “trade” a $2 million retirement portfolio using day-trading rules is a recipe for disaster.
Where Should I Put My Money if the Stock Market Crashes?
If the crash has already started, it is generally too late to “put” your money elsewhere without locking in losses.
However, your “safe” money (your War Chest) should already be in Short-Term U.S. Treasuries or Money Market Funds.
These assets typically hold their value or even rise slightly during equity flight-to-safety, providing the liquidity you need to pay bills.
How Long Do Stock Market Crashes Typically Last?
The duration varies significantly. The 2020 COVID crash reached its trough in roughly 33 days but recovered to prior highs within about five months.
The 2008 financial crisis took approximately 5.5 years to fully recover on a total-return basis. The dot-com bust took roughly 7 years.
The unpredictability of recovery timelines is precisely why a Cash Bridge matters: it removes the pressure to guess when the bottom will arrive.
Should I Diversify My Portfolio During a Market Downturn?
If you hold a concentrated position—such as a large block of company stock—a downturn can reduce the embedded capital gain, making it less expensive from a tax standpoint to sell and diversify.
This requires coordination between investment and tax planning, including attention to wash sale rules and state tax treatment.
A downturn does not automatically make diversification the right move, but it can make a long-deferred move more financially efficient.
Conclusion
A stock market crash is an inevitability, not an anomaly. If your retirement plan relies on the market always going up, you don’t have a plan—you have a gamble.
At Covenant Wealth Advisors, we help clients in Richmond, Williamsburg, Reston and virtually across the United States build portfolios designed to withstand the volatility of the Fragile Decade.
We don’t do it by guessing what the market will do next. We do it by creating cash flow bridges that aim to keep income needs funded regardless of what the S&P 500 does on any given day—and by using downturns as opportunities to rebalance, diversify, and harvest losses with discipline.
Ready to get your portfolio on track to help weather a stock market crash?
Contact us today for a Free Strategy Session.
About the author:
CEO and Senior Financial Advisor
Mark is the CEO of Covenant Wealth Advisors and a Senior Financial Advisor helping individuals age 50+ plan, invest, and enjoy retirement comfortably. Forbes nominated Mark as a Best-In-State Wealth Advisor* and he has been featured in the New York Times, Barron's, Forbes, and Kiplinger Magazine.
Disclosures: Covenant Wealth Advisors is a registered investment advisor with offices in Richmond, Reston, and Williamsburg, VA. Registration of an investment advisor does not imply a certain level of skill or training. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. The views and opinions expressed in this content are as of the date of the posting, are subject to change based on market and other conditions. This content contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Please note that nothing in this content should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax, or legal advice. If you would like accounting, tax, or legal advice, you should consult with your own accountants or attorneys regarding your individual circumstances and needs. This article was written and edited by a CERTIFIED FINANCIAL PLANNER™ professional with the assistance of AI. No advice may be rendered by Covenant Wealth Advisors unless a client service agreement is in place. Hypothetical examples are fictitious and are only used to illustrate a specific point of view. Diversification does not guarantee against risk of loss. While this guide attempts to be as comprehensive as possible, no article can cover all aspects of retirement planning. Be sure to consult an advisor for comprehensive advice.