Some of you may remember the stock market crash before COVID-19. I was still in uni when the GFC hit and everyone was concerned with not being able to find a job after graduation. It was also a time when I didn’t have much money, or knowledge about investing, so I wasn’t able to take full advantage of all the bargains on offer 🙁
At this point you might be wondering why I’m telling you this story. Well, it’s because it took me years of feeling like I missed out on the chance of lifetime to buy stocks and build wealth to realise that another crash could be just round the corner. I could speculate all I wanted on what would cause the it but I knew it was impossible to determine when it would happen. I realised that all I could do was to be prepared. Hence, I say this now, start preparing for the next market crash. NOW!
Here’s some tips on how to do it:
Reflect on past market crashes
During the 5ish years post GFC, I went against the investment theory I learned at uni and tried building a portfolio out of individual stocks. If you assumed that I didn’t beat the market you would be correct. During this time, I also made a half assed attempt to get the market return by buying an ASX200 ETF (STW.AX) but later got bored of it not growing and sold at a loss. Talk about silly mistakes!
When trying to progress your personal finance journey it’s important to look at your previous experience an understand how things could be improved for next time. More specifically, you need to look at factors that were within your control and allocate time and energy towards developing actions that reduce the chance of similar errors reoccurring. Taking my actions into account one of the biggest points for improvement for myself was to learn that investing, especially in index funds, takes patience. I probably had the unrealistic expectation that I could buy STW and double my money in a year. Also, because I thought I was able to time the market I did not continue to buy more STW (dollar cost average) when it fell. The future action here was to use a dollar cost averaging strategy to buy a set dollar amount of funds at the same time each month, while ignoring the price.
When reflecting on your actions or inaction, it’s also important not to come up with actions that force you to take advantage of events outside of your control. For example, if you said, during the GFC I didn’t buy Amazon (NASDAQ.AMZN) stock at $70 so next crash I’ll buy it; you are missing the point of the exercise. The reason for this is that you could not have predicted it’s rise in stock price and you are not basing your failed action any behaviour that would yield similar results if you repeated it during the next crash. If you are dead set on finding unicorn stocks, a more useful action to set yourself would be to develop a process for evaluating possible high growth candidates to help you identify the next Amazon. Developing a process is something you can control whereas market returns are not.
Build financial strength
To take advantage of market crashes you need cash. This means that you need to start strengthening your finances by increasing your household’s excess cash flow. This means controlling your expenses and increasing your income. This will give you the cashflow to take advantage of the many buying opportunities that arise during market crashes.
It goes without saying, but non-deductible debt should be eliminated ASAP as it only acts to reduce excess cash flow. When it comes to deductible debt, many negative consequences can arise simultaneously during a market crash so you’ll need to model your household situation when a number of factors move against you. For example, what will your household finances look like if you: lost your job; interest rates go to 10% and/or your portfolio halved? How long could you tolerate these risks before having to stop investing or sell down assets? Remember, the idea is to put your finances in a situation where you can purchase as many quality assets as possible while prices are low. If you decide to take on debt to do this, you’ll need to make sure your household finances can support this increased risk.
Develop an investing plan
Developing a plan greatly increases the chance of reaching a financial goal as it helps to reduce emotional decision making. Planning for bear markets while in a bull market gives you the opportunity to think about situations while not under pressure which reduces the chance of errors. When developing a plan, it is imperative to keep your financial goals in mind and take into account your risk capacity and tolerance.
Ever since studying finance during uni I knew that it was hard to beat the market, but that fact didn’t become apparent (or real) to me until I tried to do it myself. Since then, we’ve settled on a plan to invest a fixed amount of our take home salaries every month into a diversified portfolio regardless of whether the market is up or down. We also planned to increase purchases when the market was down by reducing our cash balances. This commitment to do so was made years before the market crashed in 2020.
Prepare psychologically
Planning for a crash is actually pretty easy compared with fighting your own human nature. Going on a mad buying spree during a bear market with all your excess cash may sound easy but actually doing this whilst watching your portfolio lose tens of thousands of dollars per day is very difficult. In 2020 I constantly questioned whether I should have waited for the dip before buying – a completely emotional response. Having a plan, and sticking to it helped me avoid emotional decision making and purchase significant quantities of managed funds at cheap prices. In addition to having a plan, to prepare yourself mentally you need to accept the following:
- You will not buy your assets at the lowest point in the market – teach yourself to feel happy that you got a discount on your chosen assets
- Market price movements are beyond your control, the only thing you have some control over is the risk that you expose yourself to
- Achieving your goals is the most important thing in personal finance, generating higher returns than the market or your peers is not worth your time or energy
Concluding thoughts
I have no idea when the next market crash is going to happen or what is going to cause it. I only know that learning from experience and adequate preparation for the next crash can take years. Personally, I much prefer to be prepared for things well in advance rather than being caught with my pants down when it finally happens!
Engineer your freedom