Every major market index in history has experienced severe drawdowns. The S&P 500 fell 34% in five weeks in early 2020. It fell 57% during the 2008-2009 financial crisis. The FTSE 100 fell 50% in the dot-com bust of 2000-2003. Each time, the market recovered — but the recovery took months to years, and investors who panicked and sold at the bottom locked in permanent losses.
The most important principle: do not sell in panic
The single most destructive financial decision most retail investors make is selling equities during a downturn out of fear. This converts a temporary paper loss into a permanent real loss. To benefit from the subsequent recovery, you have to still be holding.
Research by Dalbar consistently shows that the average mutual fund investor earns significantly less than the funds they invest in — because they buy after good runs (near the top) and sell after bad ones (near the bottom). The antidote is not to be smarter about timing — almost no one is — but to have a plan you can commit to before the downturn starts.
Diversification: the only free lunch in investing
Diversification is the practice of spreading investments across different asset classes, geographies, and sectors so that no single event can destroy your whole portfolio. When equities fall, bonds often (though not always) rise. When one sector collapses, others may hold steady. Nobel Prize-winning economist Harry Markowitz called diversification "the only free lunch in investing" — you reduce risk without necessarily reducing expected returns.
Defensive asset classes
Government bonds (gilts in the UK, treasuries in the US) often rise during equity sell-offs because investors flee to safety. They provide a cushion in a portfolio. The longer the bond duration, the more sensitive to interest rates — in a rate-rising environment (like 2022), bonds can also fall, making this defensive quality situational rather than absolute.
Gold has a long history as a crisis hedge — rising during periods of economic uncertainty and currency debasement. Its correlation with equities is low, making it a useful diversifier. Its downside: gold pays no income and has no intrinsic earnings power, so in normal times it may lag equities significantly.
Cash and short-term gilts preserve capital during a drawdown and, crucially, give you the ability to invest at depressed prices during a crisis. Keeping 5-10% of a long-term portfolio in cash or near-cash assets provides both psychological stability and tactical optionality.
A downturn is not a fire drill — it is the actual exam. The investors who do best are those who decided their strategy before the crisis started, not during it, when fear makes every decision feel urgent and rational thinking evaporates.
Rebalancing: the contrarian gift of a downturn
A downturn creates a rebalancing opportunity. If your target allocation is 70% equities / 30% bonds, a sharp equity decline might push you to 55% equities / 45% bonds. Rebalancing means selling some bonds (which have held up) and buying more equities (which are now cheaper) — mechanically forcing you to buy low. This is emotionally difficult, which is precisely why disciplined investors who do it regularly tend to outperform over cycles.