We’re currently witnessing a stock market crash like no other.
Well, that’s strictly not true. Aren’t all stock market crashes the same, apart from the reasons for the crash? Even though the circumstances for a rise or fall in markets can be very specific and have an impact on how we act and react, in terms of what happens to the value of our investments:
A crash is a crash is a crash.
Regardless of the story, if you’re invested in the stock market, your holdings will, at least during the short term and assuming you remain invested, be worth less. That’s a given.
Taking away the reasons for a stock market downturn can provide increased clarity as to how to deal with the situation at hand.
Normally, most people tend to start planning for a sharp fall in the stock market when it approaches new highs. Ahead of the most recent downturn, market commentators were talking about a rapid decline, with indices and valuations reaching record peak levels.
But Covid-19 took centre stage and the market crashed anyway and much faster than expected. We will never know the magnitude of any downturn had Covid-19 not materialised.
So what now? What if it happens again?
You’ve probably been wondering if you could have done anything differently to have minimised any losses and protect your investments from such a major adjustment.
The key thing that you need to remember is that the market moves in cycles. The cycles may be long in nature but there will always be upturns and there will always be downturns.
And clearly this means that while the market will recover from recent lows, there will be another crash at some point in the future.
When exactly will this happen? I don’t know. Nobody does.
But the important thing is that you should be prepared for it and be able to cope with any short-term setbacks. Remind yourself that this is part of your investment journey and experience.
You should attempt to see through the short-term noise and understand that market downturns are normal.
Easier said than done, but having this mindset is a necessary part of the investment process.
It is very easy to be caught up in the waves of news that we get bombarded with each day.
And it is also easy to find opposing views if you look hard enough. Stay away from the salacious headlines that are telling you to buy or sell something; they’re there to sell or gain clicks.
Their focus is to target your emotions and money is a highly emotive subject. No-one likes to lose it, so the more hard-hitting the headline is likely to be.
They don’t know your financial situation and it may encourage you to do something that is not right for you.
So stay away from reading all media outlets when it comes to views on what the stock market will do or what you should be doing with your money.
What you should do is find a handful of high quality, objective and informative news sources and refer to them on an ongoing basis. Ignore the rest.
I’ve said it before and I’ll say it again. There’s too much short termism in the market, in my view.
Investing should be a long-term process and by that, I mean years. Not months or even a year or two.
Whether you’re investing small or large sums, you should be in it for the long haul. So, if you just want to try to make a quick buck over the short term, I’m not the person you should be listening to.
As I mentioned, you will come across highs and lows during your investment journey, so having a long-term mindset will enable you to recoup any inevitable losses along the way. Your plan should incorporate this and although your investments will change over the course of your expected time frame, so will your risk tolerances, which should reduce as you reach your exit point.
I’ve written about having an emergency fund before when considering starting a financial wellbeing plan.
And I’ll likely refer to it again in the future, given its importance.
The concept is the same here; when your investments take a major dive, the last thing you want to do is sell at the bottom to access additional funds.
Having an emergency fund to access cash, should you need to, is key to help if any unexpected expenses materialise.
Once you have built up your emergency fund it will give you additional peace of mid that you would not need to sell your investments at the bottom of the market or indeed, take on any additional debt.
How much you should put aside for emergencies depends on your financial circumstances, but a general rule of thumb would be to save a minimum of three to four months of income to pay for expenses, just in case.
When you set up your financial plan, you most likely had an objective in mind.
It could have been to save your children’s school fees, pay down debt, purchasing a house or saving for retirement.
Don’t forget about the reason why you started investing in the first place; as long as your average long-term return expectations remain intact, so your invested capital should be maintained.
Having your goals in mind will help you focus on your objectives and avoid making irrational decisions based on short term fluctuations.
Your portfolio should be diversified enough to enable you to spread your risk appropriately, relative to your return expectations.
You already considered this when you set up your portfolio, right?
Asset allocation, though, needs constant attention. While other factors are often in play, it is the key that determines portfolio performance.
And therefore, it is one of the most important factors that can help protect your portfolio should another stock market crash materialise.
If you hadn’t considered a plan for diversifying your portfolio across different assets, such as stocks, real estate, bonds or commodities then you could be exposing yourself to a level of risk that isn’t in line with your return expectations.
Market corrections can occur at any time.
It could happen on the first day you invest, the last or any other in between. Predicting when and if it will happen is futile. The so-called ‘giants’ of the industry have failed in calling the top and bottom of stock market cycles on a consistent basis. As the legendary former mutual fund manager, Peter Lynch said:
“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
There will always be an event that occurs to push markets into a period of decline. Whether that be geopolitical risks, interest rate adjustments, valuation concerns, profit margin disappointments, economic growth, diseases or anything else including herd mentality.
So, instead of attempting to predict when a stock market will crash or why it is happening, you need to accept that stocks can and will fall at some point. This will help you mentally as well and prepare you for the event when it occurs.
Fearing the worst before you start will result in you being either too proactive or too pessimistic at certain times in your investment process or may even result in you not investing at all.
Sharp Insights is a business, markets and wealth blog. It is dedicated to bringing you insightful and knowledgeable information so that you can make better decisions about your financial well-being and maximise the potential in your personal and business life.