It seems that everywhere you turn these days, someone is predicting the next major downturn for the stock market. And you know what? Most of them are right, at least in part. Because the truth is, it’s not a matter of if, only when. And that, in a nutshell, is the problem with stock-market predictions. Timing is impossible, and even trying to do so is often more dangerous than the drop one is trying to predict and avoid in the first place. People have been predicting the next correction/recession/depression or whatever it may be called next time, ever since the last such event 10+ years ago. And just like a broken clock, they too will eventually be right. However, that certainly does not mean it is a good idea to trust that broken clock, or that person, when it comes to your long-term investments.
Here’s the thing, after every major market downturn, you will find some who called it correctly. With millions of investors making “the call” every day, the law of large numbers holds that there will always be someone who got it right when it comes. What we often fail to see, is that for everyone who got it right, many more got it wrong. And even for those who did get it right this time, more than likely they got it wrong many, many times before. But for some reason, we only hear about people’s triumphs and not so much about their defeats.
Think of it this way. For those of us who live in the Bay Area, we all know there will be another major earthquake at some point in the future. Again, not if, only when. But does that mean it makes sense to go hide in a cave until it happens? Of course not. How much of life would you miss out on while you were in hiding? Yes, the day the earthquake actually hits, you would look like a genius, but how many days, weeks, months, years, or even decades of your life will have been wasted while you were in hiding?
So, in the face of the inevitable, but completely unpredictable, earthquake, what does a smart and rational person do? The answer is, they prepare for the day that it happens, so that they and their loved ones are as safe as possible when it finally occurs. They retrofit their house. They store food and water in an easily accessible place. They have their hand-crank radio and phone charger ready to go. They buy earthquake insurance. And the same should be true when preparing for the equally unpredictable and inevitable stock-market earthquake. As opposed to a real earthquake though, what’s nice about a stock-market earthquake, is that you may be able to actually use it to your advantage. The problem is so few people can actually do this when it happens. However, if you are properly prepared, it can actually be a good thing – something you can turn in your favor.
Let me explain.
First and foremost, you need to have a plan. You need to know how and why you are investing, and what you are trying to achieve. You should know what you are going to do in every market situation, be it up, down or sideways. This should be written down. It is your disaster plan, to be followed when emotions are running high. The last thing you want to do in a disaster is panic and let your emotions run the show.
Next, diversify your investment portfolio. Own a little bit of everything. The market-quake may affect all of your holdings, but it will affect them all differently. This, in fact, is the basic tenant of why we diversify in the first place. We should never have too many eggs in one basket as the saying goes.
Then, rebalance your investment portfolio systematically and methodically. In other words, continually come back to your original portfolio allocation. If you did the first thing on the list right, and planned properly, then your original allocation was one that should give you the best chance to reach your goals with the least stress possible along the way. And just because the market-quake has likely thrown your allocation out of whack a bit, does not mean your goals have changed, so come back to where you started.
When the quake hits, sell from the asset classes that have been hit the least, and buy into the asset classes that have been hit the most. What does that do? It forces you to sell high and buy low. Or in a strong enough quake, sell what is low, to buy what is even lower. This is how you take advantage of a market-quake. And this is why they can actually be a good thing for a rational and well-prepared investor. It allows you to buy quality assets at sale prices. You just have to have the intestinal fortitude to do so.
Finally, and most importantly, you need to have adequate cash reserves and insurance in place so that you don’t have to take money from your portfolio while it is down. The markets will recover just fine if you give them time, they always have. And that is what cash reserves and insurance are really all about, buying you time to get back on your feet.
So, there you have it, market-quake preparedness. My hope is that now, instead of fearing the next major market downturn, you might actually be able to look forward to it in some way. The truth is that we are long overdue for a market-quake, be it a small, medium or large one. The only real questions are when will it happen, and are you prepared to take advantage of it when it does?