Signs of a potential downturn have started to show in recent days, with benchmark equity indexes around the global tumbling.
When will stock prices keep falling? Not over the long term, according to Kane Brenan of Goldman Sachs, a leading global investment banking firm. He says, “We think equities will continue to outperform in 2018.”
Even if stock prices do stabilise and go up this year, it only means that the market crash has been deferred. With valuations at their current inflated levels, a crash is inevitable.
Here is how you can prepare yourself:
Keep Adequate Cash Handy
The next stock market crash could be the best time to buy equities. The shares of many leading companies will be available at a discount.
When the stock market collapsed in 2008, Apple’s shares were available at about US$25. The company now trades at US$156. Similarly, Google/Alphabet was trading at about US$325 – its current price is US$1,062.
But you will be able to take advantage of the bargains in the market only if you have enough cash. The world’s leading investors are already prepared.
According to a recent press report, Berkshire Hathaway, the world’s largest financial services company by revenue, is sitting on a cash pile of US$109 billion. The company’s chief executive officer, Warren Buffett, is a highly successful value investor. His company has become immensely profitable by acquiring other firms at rock-bottom valuations.
Plan Your Finances and Maintain an Emergency Fund
Do you require a large sum of money in the medium-term? You could be planning to acquire property or may need to meet some other major financial commitment. If you plan to finance this by liquidating a part of your stock portfolio, you should not assume that equity markets will remain at the same level when your need for funds arises.
You don’t want to be in a position where you have to sell your stocks if the markets are low. Your time horizon for your equity holdings should be at least five years. Ten is better.
Get Your Asset Allocation Right
When the markets are booming, every investor is an expert at picking stocks. Practically every share that you buy gives you a positive return. But when the crash comes, some shares will do worse than others. At that time, you don’t want to be holding a bunch of high-risk, high-reward stocks.
Study your portfolio well and ensure that it reflects your risk profile. The rise in share prices would have distorted your asset allocation.
Rebalance your portfolio so that you revert to holding the originally planned level of fixed-income securities and stocks.
If you don’t have the expertise to handle this exercise yourself, seek professional help. A financial advisor can play an invaluable role in helping you allocate your assets in the correct manner. The fees that you pay your advisor will be a small fraction of the benefit to your portfolio.
Buying Gold May Help
When stock valuations go down, there is a strong likelihood that gold prices will rise. While there is no guarantee that this will happen, it could be a good idea to invest about 5% or 10% of your total portfolio in the precious metal.
In September 2008, when Lehman Brothers, one of the leading global financial firms, went bankrupt, it signalled an important stage of the global financial crisis. At that time, gold was valued at US$884 per troy ounce. As share prices plummeted, gold began its steady rise.
Less than three years later, in August 2011, gold was trading at US$1813, an increase of 105%.
If you don’t want to go to the trouble of buying and storing physical gold, there are several other ways to invest.
Remember to Stay Invested
The worst approach that you can adopt is to sell your stocks when the market crashes. The second-worst is to promise yourself that you will liquidate your holdings when you recover your losses.
Your investment horizon should be at least five to ten years. It is a good idea to write down your investment plan so that you can refer to it when stock prices fall:
- What are your long-term targets?
- When the market falls, will you sell or continue to stay invested?
- Will you take advantage of lower valuations by making additional investments?
A written plan provides you with a document that you can refer to when market conditions change. It can help to prevent you from making emotional decisions.
Review Your Investments
Carrying out a periodic review of your investment portfolio is absolutely essential. But it becomes even more important when you expect the market to fall.
Why is that? Consider a situation where you hold several mutual funds. All of them have been providing you with good returns. But obviously, the returns of certain funds will be better than that of the others.
Carry out a careful review and weed out the funds that have high costs and subpar returns. Remember that high costs and a falling market can have a lethal effect on your portfolio.
Here are some additional steps that you can take:
- Consider whether your needs have changed since you carried out your last review. Maybe you need to make a change in your investment pattern.
- Check your liquidity. When markets are booming, investors often divert most of their cash into equities to take advantage of rising prices. That’s not a good idea, especially when a crash could be imminent.
The Bottom Line
The boom cannot last forever. Sooner or later stock prices will crash. Then why shouldn’t you simply liquidate all your holdings, wait for the market to crash, and then reinvest?
Unfortunately, if you do that you are actually increasing your level of risk. That’s because you don’t know when the market trend is going to reverse. By selling now, you could miss out on subsequent gains. Additionally, you would not know when to re-enter the market.
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