Isn’t it a great time to be an investor in the stock market? The stock market has been on a tear for over five years and every investor has made a lot of money during that period. It’s great to see our net worth increase on paper, but this can’t last forever. Historically, the stock market has a correction every 2 years or so and we are overdue for one. (A correction is defined as a 10% to 20% drop.) Personally, I think a big drop in the stock market is a great thing for long term investors because that’s when you can pick up shares at a discount. I’m excited at the prospect of a big correction! Let’s see what we can do to prepare ourselves to take advantage of the next stock market crash.
The first thing for any investor to do is to mentally prepare for a crash. Everyone loves it when they are rich on paper, but it’s tough to stomach a big drop. That’s why investors get scared and sell their investments at the worst time. If you are investing for the long term, then you have to believe that the stock market will recover eventually. A crash is a great opportunity for long term investors and you should be very happy to see a big drop.
If you have been investing through the last few crashes, you’d know that investing through a bear market is the easiest way to increase your wealth. Of course, you can make more money if you can sell at the high points and buy at the low. However, it’s very difficult to time the market. The average investor should just keep adding to their investment through the bear markets.
Don’t invest money that you need in the next 10 years
I wouldn’t invest money that I’d need in the next 10 years in the stock market. If you’re planning to buy a house, pay for college, or fund your retirement, then you should put those funds in a less volatile investment. The last thing you’d want is to sell when the stock market has crashed.
Assess your risk tolerance and asset allocation
If you haven’t been through a few crashes, then you really need to figure out your risk tolerance and asset allocation. Your personal risk tolerance could be lower than you think. In that case, you will need to allocate your assets accordingly. Probably more bonds and fewer stocks so when the market crashes, your net worth won’t drop as much. Here is a post I wrote a while back that might help you figure out your risk tolerance and asset allocation.
Ready your war chest
We were 100% invested in the stock market in the last crash and lost $200,000 in valuation. We kept investing through the bear years and we are much wealthier now. However, I wished we could buy even more during those low points in 2008 and 2009. We had good salaries and invested as much as we could, but it still wasn’t a significant amount compare to our total portfolio.
For the next crash, I’ll have more money to deploy because now I have some bond funds and other alternative investments. Our total portfolio has 20% bond and I could trade in some of these for stock if we have a severe crash. I know that’s trying to time the market, but I’m going to try it and see how it works out.
Lastly, we need to keep investing. I know we’ll see a stock market correction or crash at some point in the future, but I have no idea when. It might happen next week, 3 months from now, or even next year. You don’t want to build up a big cash position because stock might go up 15% before a 10% correction happens. Stock analysts have been predicting a crash for a few years and if you sit on the sidelines, you would have missed out on tremendous gains.
Are you prepared for a stock market crash?
The bull markets make you feel good, but bear markets will make you rich. Basically, you need to keep investing through a stock market crash. It will be scary if you haven’t been through a few of these, but that’s the most surefire way to go.
Are you excited for the next crash? I think it would be a great opportunity to increase our dividend payout for the long term. What are you doing to prepare for the next stock market crash?
Photo credit: flickr by nordique
Passive income is the key to early retirement. This year, Joe is increasing his investment in real estate with CrowdStreet. He can invest in projects across the U.S. and diversify his real estate portfolio. There are many interesting projects available so sign up and check them out.
Joe also highly recommends Personal Capital for DIY investors. He logs on to Personal Capital almost daily to check his cash flow and net worth. They have many useful tools that will help DIY investors analyze their portfolio and plan for retirement.