A Prep Guide for Investors
Form a Financial Plan
First and Foremost, a responsible investor should calculate his or her personal living expenses and set goals pertaining to their desired financial outcome; maybe it’s establishing and building up a retirement fund, in which case, the approximate retirement date, and age should dictate how much/how little money a person has in stocks.
During our lifetimes, we’ll go through multiple stock market crashes, recessions, and potentially even a depression. This shouldn’t be surprising, and it shouldn’t dramatically alter the long-term financial plans we’ve made. Often, it’s poor planning, rather than poor investments, that will harm an investor’s financial outlook. “Buy a stock the way you would buy a house. Understand and like it such that you’d be content to own it in the absence of any market,” proclaims legendary billionaire investor, Warren Buffett.
Buffett follows the Benjamin Graham school of value investing, which focuses on stocks that are underappreciated by investors and the market at large. The stocks that value investors seek typically look cheap compared to the underlying revenue and earnings from their businesses. Investors who use the value investing strategy hope the stock price will rise as more people come to appreciate the true intrinsic value of the company’s fundamental business.
There isn’t a universally accepted way to determine intrinsic worth, but it’s most often estimated by considering a company’s fundamentals, from management quality to company culture to finances. “If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes,” Buffett adds.
With that being said, regardless of how the overall market is performing, one should maintain confidence in their thoroughly analyzed investments to the point that a few years’ market crash doesn’t cause terrifying panic or warrant a complete sell-off. Investing in the stock market is inherently risky, but what makes for winning long-term returns is the ability to ride out the unpleasantness and remain invested for the eventual recovery (which, historically speaking, is always on the horizon).
The goal of diversification is not necessarily to boost performance – it won’t ensure gains or guarantee against losses. Diversification does, however, have the potential to improve returns for whatever level of risk you choose to target.
To build a diversified portfolio, you should look for investments – stocks, bonds, cash, or others – whose returns haven’t historically moved in the same direction and to the same degree. This way, even if a portion of your portfolio is declining, the rest of your portfolio is more likely to be growing, or at least not declining as much.
For example, investors who were seriously injured during the dot com bubble had most of their money in dot-com and technology stocks. If you have a diversified portfolio and remain invested for the long term, there will likely be less financial devastation when a bubble bursts. Leaving you to confidently stay the course and let the market work things out.
Another useful strategy could be investing in company’s that are known to pay out dividends during tough times, which may help lessen the blow when shares lose value in the short term.
Per Nasdaq, companies that can afford to make regular dividend payments are typically well established with a steady history of profits. They don’t have the potential for soaring gains you get with growth stocks, but their stability is appealing in a volatile market.
Build Cash Reserves
Pile up cash reserves before the stock market crash comes, in other words, always set some funds aside for running wild on a post-thanksgiving, Black Friday-esque discount bargain spree. That’s right, being prepared for the economic recessions we are all but guaranteed to experience over the course of our lifetimes also means being ready to buy up dependable blue-chip stocks when they’re simply the unintended victims of a bear market.
“The best thing that happens to us is when a great company gets into temporary trouble…We want to buy them when they’re on the operating table,” says Buffett. Keep a running wish list of individual stocks you would like to own. Set aside some cash so you’re ready for a flash sale when disaster strikes.
Let’s take a look at Carlos Slim’s fortune-building process, he’s an investor with a personal net worth valued at more than $70 billion – making him Mexico’s richest man. In 1982, the Mexican economy contracted rapidly. As many banks were struggling and foreign investors were cutting back on investing and scurrying, Slim began investing heavily and bought many flagship companies at depressed valuations.
As markets improved over the years, Slim now finds himself involved in nearly every industry within the Mexican economy, boasting a net worth equal to 5% of Mexico’s entire GDP. Barring the collapse of human civilization, no matter what markets briefly decline, he should be doing just fine.
Monitor Inverse ETFs
Established in February 2010 by ProShares, the UltraPro Short QQQ (SQQQ), is an inverse-leveraged exchange-traded fund (ETF) that tracks the Nasdaq-100 Index. This index is composed of the largest companies, both domestic and international, listed on the Nasdaq stock market, but excludes financial institutions.
The inverse-leveraged strategy for SQQQ means it attempts to reproduce a daily investment result that is roughly opposite the daily performance of its underlying index, and then multiply those results by a certain factor. This means investors in SQQQ are preparing for the greater nonfinancial stock market to struggle, explains Investopedia. Since the Nasdaq-100 tends to be heavily weighted toward technology, telecommunications, and health care stocks, the SQQQ should tend to perform well when these sectors perform poorly.
Another inverse ETF is SPXS, an extremely aggressive bet against the S&P 500, promising to provide -300% of the index’s return for a one-day period. The fund, like most geared inverse products, is designed to deliver its 3x inverse exposure to the S&P 500 – a cap-weighted basket of 500 of the largest firms in the US – for one trading day. According to ETF.com, Holding it for a period longer than that will introduce the effects of compounding, a dynamic that’s increasingly pronounced as you add more leverage to the strategy.
SQQQ and SPXS are meant to be held intraday and are not long-term investments, where expenses and decay will quickly eat into returns.
“SQQQ and SPXS do tend to decay over time,” says influencer investor Ricky Gutierrez. “So if you suck at risk management or you’re an absolute beginner, this is probably not something you’re gonna want to partake in as the overall markets tend to be more bullish than they are bearish. These inverse ETFs are just examples of where you can put some money if you see the market pulling on back and you want to proactively day trade.”
Use What You Can Afford to Lose
Set aside and invest a surplus amount of funds you have laying around that, if the worst-case scenario plays out, you can afford to lose. You have nothing but time to make money, so when you are building your treasure chest of working best practices early on, the goal is not to start trading with a large dollar amount but to find a good balance of enough money to feel motivated but not so much you become an emotional mess.
This of course changes over time with experience and the risk you scale to tolerate. Remember, anyone can make money in the stock market but it’s the few that can tolerate the risk when things begin to go south.
Become the tin man. Empty your soul of all emotion when stepping up to the trading screen. Good or bad, don’t feel it. Make decisions based on logic and make sense of the consequences of those choices with reason, that way no matter what, you can always build on your experience.
“Losing money because you bought right before a price drop and then sold before a price rise because you were frustrated or disheartened is a terrible feeling. When this situation occurs, traders often think their timing is off, or they’re out of sync with the market,” explains Cory Mitchell, an investment writer for The Balance. “While that may be true, a better way to look at it is a lack of patience. Impatient trades lead to unnecessary losses, additional stress, and wasted emotional energy.”
Legal Disclaimer: I am not a certified financial planner/advisor nor a certified financial analyst nor an economist nor a CPA nor an accountant nor a lawyer. I am not a finance professional through formal education. This Content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.
If you enjoyed this guide of ways to prepare for a stock market crash, be sure to check out our list of Day Trading Rules that Beginners Should Know.