It wasn’t a great week for the market, with the All Ordinaries dropping a further 3% from its August all-time high.
And there’s plenty of reasons to be nervous.
The US Federal Reserve is winding back stimulus and signalling higher lending costs. China — our largest trading partner — is facing a potential credit squeeze and property market slump, while trade and political tensions continue to escalate. And all while market valuations remain relatively stretched — at least against historical measures.
Michael Burry (the guy played by Christian Bale in ‘The Big Short’, who famously called the 2008 financial crisis) tweeted earlier this year that we’re in the “Greatest Speculative Bubble of All Time in All Things” (the tweet has since been deleted).
The difficulty, of course, as Peter Lynch once observed, “far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
In other words, the occasional crash is something we should just accept as an occasional backward (albeit scary) step in an otherwise long and lucrative journey. Indeed, as many only tend to realise after the fact, a big market correction is usually a wonderful thing for the savvy investor.
So it’s pretty basic stuff really: stay invested, add regularly and focus on the long-term. Everyone ‘gets it’…at least when considered from a position of comfort.
The reality though, is entirely different.
While the idea of super cheap shares is nice, you only get that when there’s some really scary, uncertain stuff going down. And that’s at a point where you’re already wearing some potentially significant losses.
Interestingly, it’s not just the “noob’ investors that struggle here — according to some recent research from MIT, “Investors who are male, or above the age of 45, or married, or have more dependents, or who self-identify as having excellent investment experience or knowledge tend to freak out with greater frequency”
While we all like to think we’ll behave a certain way in the next crash, the odds are most of us won’t. And a crash is definitely coming (we just don’t know when).
There are, however, some practical steps we can take to ensure we are well placed to weather any storm, and take advantage of any opportunities that may arise.
1. Ask the What If
How well would your companies hold up under difficult and protracted economic conditions? How dependable are cash flows, and what safety does the balance sheet afford?
All shares suffer in a crash, but only those in sound companies bounce back.
Thinking through the consequences in advance will go a long way to avoid any panic decisions later on.
2. What’s on your wishlist?
If the market did go on sale, what companies would you buy (or what existing holdings you would add to)? What price would you need to see before you acted?
Again, better to have thought this through in advance.
3. Can you endure?
If you have any major capital expenditures planned in the next year or so (say, a deposit on a house), you might want to consider keeping a good part of it out of the market. Yes, you’ll regret it if things remain favourable but, at the same time, if you need to drawdown during a crash, you’ll be selling at the worst possible time.
It’s almost always a good idea to only buy shares with money you can afford to leave untouched for 3 or more years.
The bottom line
Whatever the future holds, remember this: a good captain spends more time in ensuring their vessel is in good shape, than in trying to guess what the weather is like beyond the horizon.
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