Stock market crashes don’t have to be painful.
Following best practices will help you navigate them with ease.
As you know, the coronavirus has sparked the largest stock market crash in recent history: the S&P 500 is down 30% in the last month and may be headed lower.
Countries around the world are in lock-down and economies are at a standstill.
Major companies are set to lose big money so investors are panicking and liquidating their assets to raise cash.
What strategies should investors implement to minimize losses?
Although there are no 100%-guaranteed ways to weather a prolonged bear market, there are simple, time-tested strategies investors can rely on to limit losses and prepare themselves for the eventual return of the bull market.
1. Do not panic sell solid stocks
So what if you’re down 20-25%? Zoom out and look at the 10-year chart.
Chances are that this stock has experienced dips before and recovered.
Take advantage of this dip to purchase shares at a discount and reduce the dollar-cost average of your position.
It will feel like catching a falling knife but good companies always bounce back once a crisis is over.
Question: How do you know if you’re holding a good company?
Answer: Due diligence and research.
Hopefully, you always research the companies you want to invest in before you purchase their stock! If you don’t, then you’re a gambler, not an investor. Sure, investors gamble on risky stocks every now and then (I’m looking at you Virgin Galactic), but these gambles represent a very small part of their portfolios. Your portfolio should consist mainly of S&P 500 index funds and large-cap companies with solid balance sheets and positive cash flows.
3 examples of great companies you should not sell and consider buying:
They produce phones and accessories that sell like hot cakes. Every year, their earnings increase, and they have close to $250 billion dollars in cash reserves. Do you think the coronavirus-induced recession is going to wipe this company out? I wouldn’t bet on it, and I wouldn’t sell my Apple stock either! Any dip is a great opportunity to purchase this stock at a discount.
Look at the long-term chart: nothing but growth. This reflects the growth of their business and their healthy balance sheet. Microsoft is the leader in cloud computing, and, like Apple, they have over $200 billion in cash reserves. Having that much cash on hand means they can buy out potential competitors and invest in R&D that will allow them to innovate and remain market leaders. Buy the dip? Heck yes.
What’s not to like about this stock? This company has done nothing but grow over the past 20 years. Plus, society is progressively going cashless and they will profit from this trend. It’s a rock-solid business with a quasi impenetrable economic moat. Count how many people you know have a Visa card. Buy the dip.
2. Quickly sell off your speculative gambles
This piece of advice applies to stocks that got swept up in the bull market euphoria.
During a bull market like the one we recently experienced, many poor stocks get pumped up far beyond their reasonable valuation. This results in unjustified prices that are due for corrections. Once a cash occurs, these stocks take a beating and sometimes never recover. The sensible thing to do is simply to sell these stocks as fast as you can to raise the cash you will need to reinvest in solid value companies like the ones we mentioned above.
Examples of overvalued stocks are numerous: think of those stocks that skyrocket in value based on future promise rather than actual products and profitability.
One stock that immediately comes to mind is Plug Power Inc. Although I believe in their products, their stock’s long-term chart is frightening. In 2000, this stock peaked at $1500; today, it’s worth less than $3. Maybe one day it will reach $1500 again, but for the time being, all I know is that those waiting 20 years have lost out on major gains in other stocks.
I hope that those who invested in this stinker managed to get out before their losses were too great. Sometimes, you must bite the bullet and move on rather than hold on to heavy bags in the vein hope that it may, one day, recover.
We all have stocks like this in our portfolios. My advice is to dump them before the hemorrhage bleeds you dry and allocate whatever cash you salvage to more reliable investments.
Advanced strategy: The advanced strategy is to short these speculative stocks that are bound for the ground. However, this is extremely risky and should only be carried out by experienced investors. Also, when markets crash and are at the mercy of speculators, some countries ban short selling altogether.
3. Buy US Treasuries
Although US T-Bill yields are absurdly low, they can provide some protection against a downwards spiraling market.
One option is to sell off your speculative gambles and reinvest that money in short-term bonds that will slightly offset inflation. Losing 1% to inflation is better than losing 25% in the stock market!
Short-term bonds expire quickly, allowing you to reinvest your money as soon as the market recovers.
4. Hedge your risks with gold?
One common hedge is buying gold and silver. However, the price of gold will not necessarily skyrocket at the exact same time the market plunges.
Nevertheless, Gold is a great investment and should play a part in your portfolio. However, don’t be fooled into thinking that selling all your stocks and going all in gold will make you an overnight millionaire. It won’t. Gold is a long-term hedge against major disruptions in the world order.
5. What about Bitcoin?
Bitcoin is often touted as being a safe haven against market downturns but this is proving to be false. Indeed, Bitcoin has lost 50% of its value in the last month and could be headed lower.
Despite this atrocious performance, I believe that Bitcoin will survive this crisis. The collapse in price is due to investors moving their money out of the market in order to raise cash for immediate purposes. If anything, this spectacular decrease in price may be the long-awaited dip that in hindsight will be regarded as a great dollar-cost averaging buying opportunity.
6. Convert to cash and wait for rebound
This last piece of advice is targeted towards those who are extremely fearful and don’t want to invest at all during bear markets. Although you should never try to time the market, bear markets are as good a time as any to to stash your cash away in a savings account. You can reenter the market when the economic climate becomes more favorable and the stock market begins going up again,
The only risk is mistiming your reentry and missing out on the gains that the dollar-cost averaging crowd will make by investing all the way to the bottom then riding the wave back up. But hey, you can’t eat your cake and have it too.
When it comes to shopping, people eagerly anticipate sales season to buy the items they want at a discount. The paradox of the stock market is that people buy when the price increases and sell when the price decreases. Absurd isn’t it?
However, if you implement some of the basic strategies presented above and follow Warren Buffet’s time-tested advice of being greedy in times of fear, you will limit your losses and position yourself for huge gains when the market becomes bullish again.
Don’t panic, and remember that capitalism works in boom-bust cycles. Look at the 50-year S&P 500 chart and you will see that investing is indeed a long-term game.
Disclaimer: This is not financial advice. Do your own research before investing in any asset.