4 Ways to be Ready for the Next Market Crash
Updated: Oct 6, 2020
The New York Stock Exchange, commonly known as Wall Street has been around since 1817. For about the first 100 years of Wall Street, railroad and transportation dominated the market but the industrial revolution introduced more sectors and the market started to become more diversified. Since the early 1900’s there have been many market corrections, which is defined as the price of the market dropping 10% or more from its recent 52 weeks high. Some of these corrections are referred to as crashes as the drop in prices was sudden and steep. The five most talked-about crashes in modern US history are the Great Depression in 1929, Black Monday in 1987, Dot Com bubble in 2000, the Financial Crisis or Great Recession in 2008 and now the Corona Virus Pandemic in 2020.
During the Great Depression, the ultimate bottom of the market was reached in July of 1932 which was a staggering 89% drop in prices from the previous peak in Sept 1929. During the Great Recession, which most of us can remember, the market hit the ultimate bottom in March of 2009 which was a 50% drop from its previous peak in October of 2007.
And now the Pandemic we are all living in today. The Dow Jones hit a high of 29,568 in February of 2020, and as the news of the novel Coronavirus and the virus itself spread rapidly and the WHO declaring a pandemic on March 11, 2020, the markets began to tumble, hitting a bottom at 18,591, on March 23, 2020. This represents a drop of 37% at a record pace. Many experts started to talk about a V shape, U shape, and W shape recoveries and now that we are six months into the pandemic, depending on the chart you look at, it can resemble a V or a sideways L, but we are not out of the pandemic yet so a W might still happen. There is still a lot of uncertainty, confusion, millions out of work, and both federal and state governments trying to do whatever they think is best to control the bleeding and minimize the blast radius.
The only thing that is certain is that there will be another crash and more corrections in the future and the people that are prepared create personal wealth, sometimes generational wealth, during these downtimes. So how can you be better prepared?
Be a Student of the Markets
The first thing you have to do is educate yourself. You don’t have to become an expert in reading charts, financial statements, and all the various ways professional traders buy and sell equities and commodities. You just have to keep a pulse on the market and have a basic historical understanding. As an example, during the last 35 years, there have been roughly 24 corrections or downturns. On average, one every sixteen months and on average, each lasting 67 days. Having an understanding of trends and historical data can help you make better investment decisions instead of following the masses. While this article is focused on the stock market, don’t ignore the real estate market as understanding both will make you a better well-rounded investor as they are connected. I will talk about the real estate market in a future article.
Boost Your Savings
You can’t play if you don’t have the cash to buy into the game. Boost your savings as much as possible so you are ready to pounce when the time is right. I missed out on the Dot Com bubble because I had recently graduated high school and was a poor college student, focused on school, and wasn’t even paying attention to what was happening around me. In short, I was uneducated with no savings so even if I wanted to, I couldn’t game in the game. But as I was peripherally hearing stories of people making a lot of money in the market I began to pay attention. After the Dot Com Bubble and the downturn caused by the 9/11 terror attacks, I made a commitment to myself that I will be ready for the next time. I opened up a second savings account, threw away the ATM card, and religiously began to move all extra cash at the end of each month into this account.
As a few years passed, I began seeing people buy homes that couldn’t afford to buy homes just a year earlier, and others in my age range buying fancy cars and multiple homes. Something about the picture didn’t look right but I thought to myself that once again I missed the boat. This time it was the real estate market. I had already built a strong habit of savings so I continued while feeling like I was on the sidelines watching others prosper. Well, we all know how that ended. The financial crisis started showing its signs in 2007 and by September of 2008, we were in a market crash.
At the time I didn’t know when the bottom will hit but based on studying trends and historical data, I decided to move most of my savings into equities around early March of 2009. In hindsight, March was the bottom of the stock market so my timing was just right. I held that investment for about 7 years where my initial investment had grown more than tenfold and it became the money we used as a down payment to buy our house and fully remodel the house to our liking. In addition, because I had studied the real estate market, I was also able to finally play in real estate buying my first investment property in 2011. Again, in hindsight, my timing was right with that investment as well.
After you study the market and have a broad understanding of historical trends, begin using one of the many simulator options to invest with fake money. When I say study the market, this involves understanding historical trends, and data but also, keeping a pulse on a specific sector. You want to go deep instead of wide. My job forces me to stay current with what is happening in media and technology so I decided to only focus on media and technology companies. I do not invest in companies where I do not understand their business model and if as part of my daily routine, I do not stay current for what is happening in an industry. Pick your one or two industries, identify companies you may want to invest in, and invest in them with fake money. There are a few goals for this exercise. One, this forces you to build habits to keep current and follow the market. Two, you get to test out your decisions without any real financial impact. Three and most importantly, you want to become self-aware of your emotions and you’re emotional reactions and slowly find a way to manage any decisions that are rooted in emotion. Investments rooted in emotion are usually bad investments, especially when FOMO kicks in. There will always be some level of emotion involved but you don’t want your emotions to be the driving factor behind your investment decision.
Have a Plan
You have educated yourself, have the cash ready, and used simulations to hone in on your industry and become self-aware of your emotions. Now you need a plan. No one can predict the next downturn or a major crash so you can’t have a plan that revolves around which companies you want to buy. Instead, your plan comes down to how comfortable you are with taking risks. As an example, a plan can look something like this.
When stocks fall 10% from a recent high, I will invest 25% of my cash and monitor closely.
If stocks fall 30% from the recent highs, I will invest 50% of my remaining cash and stay in for 18 months.
After putting in most of my savings into stocks in March of 2009, my habit of savings did not stop. I knew that based on history another crash will happen again and almost eleven years after, the Corona Virus crashed the market.
My plan was to invest 15% of my cash whenever the market dropped 10% and this happened several times between 2009 and 2020. Knowing that a market crash of over 50% is rare, my plan was that if the market crashes more than 35%, I will invest 80% of my cash. The Corona Virus crash was so sudden that the market went from 10% down to 35% down in a matter of days. On March 18, I stuck to my plans and put 80% of my savings into the market. I made this decision based on historical trends, obsessively following the market from when the downtrend began in February and keeping a pulse on what governments were doing worldwide and since the US stimulus was looking very likely to be signed soon, I bet that we were close to a bottom. It turned out that the bottom (for now) was March 23rd and the Cares Act was officially signed on March 25th. The market as a whole has mostly recovered with some companies even surpassing their previous highs while others struggling to stay afloat. We are not out of the woods yet and anything can change but my timing seems to be good once again.
You also need a plan for when you will sell. You need a goal while keeping in mind that there are short term and long term capital gains taxes you have to pay. If your goal is 30% return, then factor in taxes and sell when you have hit your goal. The worst thing you can do is get greedy when you are up on your investment.
The decision I made around 2003 to have a savings specific to allowing me to be in the game changed everything. Sure, a 10% gain at first might only mean $300 but as your investment grows, 10% can mean $10,000. For amateur investors, it’s a long game. Don’t get caught up in day trading, shorting or other tactics professional lose. As an amateur, you probably have better odds in Vegas compared to trying to act like a professional trader.
Above are my opinions and should not be regarded as Profesional advice.
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