The market's recent shakiness might portend a crash in the near future. Or, it might not. There's no way to be certain, and sitting on the edge of your seat in the meantime is a surefire way to feel bad while also missing out on gains.
Rather than worrying and remaining passive about the prospect of a market crash, keen investors take action to control their portfolio's future. While there's no way to completely avoid the negative impact of a correction or collapse, using the three tactics I'll discuss today will ensure that you can treat these events as the opportunities that they are.
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1. Reframe your perceptions
Let's assume that you're an investor who is investing for the long term to prepare for retirement or to build wealth. You probably buy stocks somewhat regularly. And when you pick a stock to buy, you likely take a peek at its recent performance to get a feeling for its value.
If the above sounds something like you, there's a lot you could gain from a market crash. However, you'll need to think about crashes differently. It's impossible to find the silver lining amid a kerfuffle if you're too focused on the chaos.
When you consider a stock to buy, you're making a judgment about the prospect of its price increasing in the future, based on the characteristics of the business and the industry where it competes. If you believe that it'll grow, you then consider whether that future growth is worth the current price. If everything checks out, you might buy the stock.
So why wouldn't you want to buy a stock that you're confident in, if it's on sale as a result of a crash? Crashes are marketwide phenomena that are external to the value of any single company. Once you're confident about the future prospects of a company, getting a large discount for its stock on the day of the crash is practically a gift.
2. Make a watchlist that's a wish list
Now that you're ready to recognize a plummeting market as a chance to buy the stocks you want on the cheap, you'll need to make a shopping list for the day of the sale, should it come.
I divide my "buy after a crash" watch list into two categories: Timeless stocks, and growth stocks. The timeless stocks include companies like Abbott Laboratories (ABT 1.21%), which pay a dividend and are rarely available at a big discount. If the market collapses, the dividend yield of stocks like Abbott will rise, meaning that it's a juicier purchase than usual.
Plus, these stalwarts have the added bonus of an extremely broad base of revenue. In the case of Abbott Labs, that revenue is derived from products that are always going to be in demand, like diagnostic tests and surgical hardware. So, if the market's slide is being caused by some kind of economic or political event, the timeless stocks are still pretty safe in the long run.
My post-crash growth stocks watch list includes companies like Novavax (NVAX 1.33%), which tend to be somewhat overpriced in normal times as a result of overly optimistic estimations of their future revenue. Thanks to Novavax's soon-to-be-commercialized coronavirus vaccine, the company will still see a healthy level of demand even if economic conditions deteriorate -- but not reliably for many years, as with Abbott Labs.
The trick is that a market correction could bring outlandish guesses about Novavax's future revenue back into the realm of the possible. Therefore, keeping it on my watch list ensures that I'll get a chance to buy it at an appropriate price rather than a hype-driven high price. Of course, betting on Novavax after a crash is riskier than betting on Abbott Laboratories. Because Novavax is still working on getting its first product out the door and it doesn't pay a dividend, its stock might take longer to rebound to its prior level.
3. Build a stockpile of cash
Once you have your wish list ready, you'll need to have enough cash on hand to actually buy a significant amount of stock when it's still cheap. It's perfectly acceptable to spend several months stashing away whatever you can to prepare.
The amount you keep is up to you, but it probably shouldn't be a huge percentage of your portfolio's total value. Keeping cash on the sidelines in anticipation of a buying opportunity is a good practice, but if you reserve too much for too long, it'll eat into your portfolio's growth. I try not to keep more than 10% of my portfolio's value in cash at any given time, but if you're a more aggressive investor that might be too much.
After you've accumulated your dry powder, all that's left to do is live your life as normal. If a crash does occur, you'll be fully prepared to get the most out of it when the time is right.
On the other hand, if there isn't a crash, you can sleep soundly at night, knowing that you'll be ready if opportunity knocks.
