A Market Crash Is Coming

I hope this doesn't surprise you: Another stock market crash is on its way.

That's the bad news. The good news is that the crash probably isn't right around the corner. Many financial prognosticators on TV will offer opinions on when the next big one is due, but I don't feel I'm shortchanging you with my opinion:

I don't know when it will happen.

This is the best, most honest answer anyone can offer, because even though the arrow usually points up over the long term, the stock market's short-term movements are extremely unpredictable.

There are many things we can learn by looking at past crashes. At about.com, I found Dustin Woodard's assessment of the United States' 10 worst stock market crashes:

What to learn from this
How can this information help you? Here are a few key lessons:

Regrettably, some of the crashes followed one another closely. For example, the Dow sat near 400 in 1929, but it remained below 100 by 1942. One could argue that in this period, there was one long crash instead of several small ones.

A big question the data raises is this: What caused the carnage? Reasons have varied over time. The Depression years included several crashes, and there was one during and one soon after World War I as well.

Other factors tied to crashes include inflation, speculative trading, insufficient regulation of the market, automated trading, and trade and budget deficits.

Sometimes, crashes occur without clear reasons. The 1987 crash, which featured a one-day 23% drop, for example, has many alleged causes, but no single, definitive trigger I could find.

A last thing to notice is that there have always been recoveries, and the market trends upward in the long run. Sometimes, we have to wait a long time for a full recovery. This is especially true for those who invested in market darlings that soared, often unreasonably, before crashes happened. The Nasdaq 100 index, for example, made up of 100 of the biggest technology companies listed on the Nasdaq (and tracked by the PowerShares QQQ (Nasdaq: QQQQ) exchange-traded fund) more than doubled between 1999 and 2000, and remains below 1999 levels today.

What to do about it
Let this information shape your investing, Let it remind you that anything can happen in the coming five or even 10 years. And remember that you should have only your long-term money in stocks. You don't want to lose that sum you've socked away for a down payment on a house or for college tuition. Here are a few takeaways:

If you're frightened of any kind of significant drop, you might want to place stop-loss orders for your holdings with your broker. You can, for example, specify that if Stock ABC falls 10%, you want it sold ASAP. This can protect you, but it can also evict you from some great performers that slump temporarily.

Look for opportunities in crashes. If you have some cash on the side, or can generate some, you might be able to take advantage of some first-rate bargains -- although, again, it might be a few years until you're rewarded.

For example, on "Black Monday" in 1987, Home Depot (NYSE: HD) stock fell 25%, from about $20 to $15 (which in today's split-adjusted terms would be a drop from $0.59 to $0.46). It gained back that ground within a few months, and it had more than doubled within two years. Recently it was trading around $25 per share, representing a 54-bagger for 1987 investors. Look at ExxonMobil's (NYSE: XOM) chart, and you'll see that investors who bought during 2001's opportunity have done rather well.

Consider investing mainly in certain kinds of companies -- stable growers that pay significant dividends that you'll receive no matter what the market is doing. Look at this chart of Procter & Gamble (NYSE: PG), for example, and see how rocked it was by the 2000-2002 market crash. Wells Fargo's (NYSE: WFC) chart also shows the value of hanging on to steady growers. Over the past decade, through market ups and downs, Procter & Gamble's dividend has grown by a compound average rate of 11%, and Wells Fargo's has grown by 14%. (Some other dividend-paying companies worth a closer look are Bank of America (NYSE: BAC) and Diageo (NYSE: DEO), recently yielding 8.7% and 2.8%, respectively.)  

If you're interested in adding some (or many!) significant dividend payers to your portfolio, I invite you to test-drive, for free, our Motley Fool Income Investor newsletter service. Its recommendations have been beating the S&P 500 by eight percentage points on average, and those picks sport an average dividend yield of 5%. A free trial (with no obligation to subscribe) will give you full access to every past issue.

Here's to doing well through the coming crash!

This article was originally published on March 21, 2007. It has been updated.

Longtime contributor Selena Maranjian owns shares of Home Depot. Diageo and Bank of America are Motley Fool Income Investor picks. Home Depot is an Inside Value recommendation. The Motley Fool is Fools writing for Fools.