What You Can Do About The Upcoming Stock Market Crash
So you have some money you want to invest but you’re worried because you keep hearing that there’s going to be a stock market crash. Isn’t it better to wait until after that happens so you can buy in when it’s safer?
It’s true that the stock market will crash. In fact I guarantee it. The only problem is that no one knows when it will happen. It might be tomorrow, or it might be five years from now. That means it’s very hard to do anything about it.
Related: What are you doing with this stock market pullback?
It’s an understandable fear right now. We are just a few years past one of the biggest recessions any of us have seen. Expecting that to happen again just because that’s what we remember is the same mistake that caused the disaster in the first place.
Investors and money managers forgot that things could go wrong and didn’t protect themselves. Now many of them have forgotten that things can go well and won’t take good opportunities. Either mistake can cost you a lot of money.
Think about the countless millions of investors who didn’t manage to avoid the stock market crash, then got out of the market after losing a lot of money and missed the recovery! If they had simply done nothing they would have been back to even after a few years and making a profit after that. Instead they lost money while trying to protect themselves.
Related: When is the best time to invest?
It seems so easy to avoid a crash, why is it that almost no one actually does? As the legendary investor Peter Lynch said:
“More money has been lost trying to anticipate and protect from crashes than actually in them.”
Losing Even if You’re Right
Let’s say you did wait until after a big dip, correction, or crash to buy into the market. The first problem is that even if you get it right you can still lose money in the process. Wait, what? How could avoiding a drop in the market cost you money?
Imagine two investors, Johnny and Jane, who both have $10,000 to invest at the start of this year.
Johnny is worried about bad news and sits on his cash “until things get safer”. Jane knows that being invested in the market for as long as possible will make her safer so she buys a diversified list of index funds in several countries. It turns out that 2015 is a pretty good year as Europe avoids a meltdown (again) and the US economy grows a bit faster than expected.
Related: Does international diversification still work?
Jane’s index funds go up 15% this year and she gets some dividends to end up with $11,700. Johnny gets a bit of interest on his savings account at the local bank and ends up with $10,025. Then at the start of next year some bad news comes out and the markets drop by 10% in a month.
Now Johnny must be feeling good since he avoided that hit, right? Not so fast — after Jane loses 10% she still has $10,530 while Johnny only has his $10,025!
Johnny is smart enough to know that the market can keep going down even more. Will it be like last fall when markets rebounded the next month? Or is it the start of a global meltdown? No one knows, but he’s too scared to invest in a falling market because the risk is always there.
That doesn’t sound like good protection. I’m not predicting what will happen this year or next year but examples like this are constantly happening in the stock market. Most of the time the market is going up. If you are invested for a long enough time you will be making money before and after any crashes that come along, probably a lot more than you lose in those crashes.
Related: Market corrections – Should you buy, sell, or ignore?
Think about it — would you rather win $100 in a contest and have to give back $20, or only win $20 and keep it all?
How Can You Actually Protect Yourself Against a Stock Market Crash?
All this sounds nice but there is still a real risk that markets will go down right after you invest and you will regret your decision. And even if they don’t, when it does happen later on it’s very scary and you will be tempted to get out at the worst time.
We’re only human after all and those are natural reactions for us, just like jumping when we see something flying at our face even if it’s only in a 3D movie. We can’t just ignore fear and regret.
When you think about it that risk and fear will always be there no matter how far the market goes up, down, or sideways. So what can you do?
Be prepared for a stock market crash at any time. If you need to withdraw money in the next few years or you want to cushion the blows, then you need to diversify your portfolio with enough bonds, cash, or other assets that won’t fall along with the stock market.
Once you figure out what is right for your current situation you don’t have to worry about what happens because you are controlling the risks instead of letting them control you. That means you are safe to invest your money today and start earning your way to the freedom you want for yourself and your family.
Related: Why investors should embrace simple solutions
The investors who do really well aren’t the ones who guess when a stock market crash is coming. They’re the ones who make a plan so they don’t have to worry about crashes, invest as early as possible, and stay invested as long as possible.
Following a simple and solid plan will earn you a lot more. Trying to figure out what the market is about to do will just add stress to your life.
Richard is a passionate index-investor who teaches investors how to build an indexed portfolio they can believe in at Master Your Portfolio.
We once put $150,000 (from severance pay) into the stock market just before a huge crash. The above advice didn’t help because there was no time for it to grow first (though it did buffer the loss a bit that we were well-diversified). Since then, whenever we get a fairly large amount of money to invest (not that it happens frequently, but big work bonuses and an inheritance did), we do dollar cost averaging over 1-2 years (depending on the economic forecast). It prevents all of it from going in just before a crash yet gets it invested without waiting for a crash to happen.
Oh! I get it — so if you have a lump sum, you spread the investing out over a certain span of time.
That’s a great tip. Thanks for sharing.
Spreading your investment out over a short time period is still better than waiting until the market is “safe” (this time never comes, right after a huge drop no one is in a hurry to invest). In the end we can never know the perfect time until it’s too late so if it’s a large amount for you then you do need to be prepared for the market to crash immediately after you invest. If it’s an amount that you get regularly then by investing it as soon as you get it the ups and downs will average out.
Tracy, remember though, even though the market crashed just after you invested, it was only temporary and the market later went on to new highs (as it always does), so you didn’t lose anything. The market goes up more often than it goes down, so you are better off investing it all at once. If you spread it out you are more likely than not to be investing at higher and higher prices. As Warren Buffet says, these market fluctuations is just “meaningless volatility” unless you need the money within about 5 years.
Hi Tracey, this article by Dan Bortolotti is worth a read: http://canadiancouchpotato.com/2013/05/31/does-dollar-cost-averaging-work/
“Investing the lump sum might result in higher blood pressure, but it’s also likely to deliver higher returns.”
“If you’re extremely anxious about going all-in, and you’re willing to accept the likelihood of lower returns, then a gradual investment is entirely reasonable. But stick to a strict timetable, investing equal amounts each month or each quarter, for example. And don’t spread it out longer than a year, as you’ll lower the odds even more.”
I agree that lump sum investing results in higher expected returns compared to dollar cost averaging, but in practice I tend to see that dumping a big chunk of new money into the market is intimidating for people. Despite the evidence in favour of lump sum investing, I have seen very few individuals willing to invest a large windfall all at once.
The right answer will be different for everyone; Dan’s post nails it.
I like to see any systematic plan to get into the market over a specified period. Without that it’s all too easy to think that “next year will be better”!
It seems to me financial advisors are more concerned about less paperwork than if you lose a ton of money. My father’s financial advisor suggested he put in his money in a lump sum to save time on paperwork. I’m glad I told my dad to do dollar cost averaging because the market dropped a ton after he invested.
People should be investing for the long term and taking advantage of dividend income along the way. There are a lot of high quality companies out there paying dividends in the 4% range with strong growth profiles based on solid earnings. If you buy them, hold them for 5-10 years you will seldomly be disappointed while collecting an above average, growing pay-cheque along the way.
investing in inverse etfs and tvix or hvx should mitigate big losses
Don’t dollar cost average down in a falling market either.
That’s like falling down a flight of stairs!!
That is hvu not hvx for canadian accounts…tracts volatility of s&p when markets crash.
Also purchasing puts on favored holdings is another way to protect holdings without selling…like buying insurance