For most Americans, it's a thrill to know we're on the downswing of 2020 -- and it only took what felt like five years to get to this point. That's because the coronavirus disease 2019 (COVID-19) pandemic has completely undone societal norms, shut down a number of nonessential businesses, pushed more than 20 million people out of work, and caused record-breaking volatility on Wall Street.
It's been an especially wild year to be an investor. In less than five weeks, the benchmark S&P 500 (^GSPC +0.80%) plunged 34%, representing the fastest bear market descent in history. But in the following three months, the broad-based index gained back most of what it lost, with the technology-focused Nasdaq Composite ascending to new all-time highs. As I said, it's been quite the year.
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However, history suggests that another stock market crash or correction is coming. Of the past eight bear markets, there have been 13 total corrections of at least 10% within the three years following a bear market bottom. This means the typical rise from a bear market bottom features one or two substantive corrections.
In other words, you need to be prepared for the next stock market crash. Here are the 10 things you'll want to do (and know) when the next big downdraft in equities arrives.
1. Relax, corrections and crashes are inevitable
First of all, relax! Stock market crashes and corrections are a natural part of the investing cycle, and they're going to happen whether you want them to or not. Since the beginning of 1950, the S&P 500 has undergone 38 corrections or at least 10% (not rounded), working out to a correction every, roughly, 1.8 years. They're a lot more common than you probably realize.
2. Understand that corrections are short-lived
You should really understand that, while unpleasant, stock market crashes and corrections tend to be very short-lived. The COVID-19 crash, for example, lasted a mere 33 calendar days.
Since 1950, 24 of the 38 stock market corrections in the S&P 500 have found their bottom in 104 or fewer calendar days (that's about 3.5 months). In fact, only three corrections in the past 36 years have lasted longer than the 104-calendar-day mark. Computers and the internet have leveled the playing field between Wall Street and Main Street, in terms of access to information, which, in my view, is likely responsible for these shorter periods spent in correction.
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3. Keep emotion out of the equation and avoid panic-selling
Investors would also be wise to keep their emotions of out of their decision-making process. While emotions tend to drive stock market crashes, operating earnings growth is what sends equities higher over the long run. Thus, short-term worries rarely have a lasting impact on the growth potential of great companies. If you panic-sell during a correction, there's a good chance you're going to regret it.
4. Reassess your holdings
Fourth, consider reassessing your holdings. Keep in mind that you don't need a stock market crash to revisit your portfolio, but it's usually the impetus that coerces investors to review their investment theses.
In short, ask yourself if the reason(s) you purchased a stake in a company still holds water today. In many instances, your investment thesis is going to be unfazed by a few bad months for the stock market. If, however, your investment thesis for a company has been materially altered, then it might be time to sell.
5. Avoid margin like the plague
When the stock market crashes next, make sure to avoid margin like the plague. Although using leverage can magnify your gains if you're correct, it can also intensify losses if you're wrong. That's a problem when timing the market in the short-term simply isn't possible with any ongoing consistency. Unless you're a tenured investor who feels comfortable short-selling stocks and fully understands the risks associated with borrowing money, you should avoid utilizing margin in any capacity during a crash.
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6. Be a nibbler, because timing the market is impossible
Everyone has their own method of buying stocks that makes them feel the most comfortable. During a stock market crash, I encourage folks to be nibblers. With most brokerages eliminating commission fees tied to buying and selling equities on major U.S. exchanges, you can dip your toe into the pond and take small bites of great companies as often as you'd like.
Plus, since timing the market isn't something that can be done with any accuracy, nibbling will ensure your chance to buy high-quality businesses at a discount.
7. Add to your winners
Maybe the most important piece of advice I can offer to you is to add to your winners during a stock market crash. In the investing world, it's not uncommon that winners keep winning. Businesses that have clear competitive advantages, offer game-changing innovation, or are producing significant profits, are usually the types of companies you'll want to add to during a correction.
For instance, Amazon (AMZN +3.47%) never declined more than 9% on a year-to-date basis in 2020, and is now up close to 56%, through July 1. Amazon has benefited from a significant COVID-19-related uptick in online purchases -- Amazon holds close to 40% market share in U.S. e-commerce -- and has seen its faster-growing cloud-services segment become an increasingly larger component of total sales. Amazon's rapid operating cash flow growth shows it's a winner that'll just keep winning, stock market crash or not.
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8. Don't skimp on growth stocks
Investors would also be wise not to overlook high-growth stocks or highly innovative companies during a correction or crash. In the current economic environment, lending rates will likely remain near record-lows through 2022, which will encourage high-growth businesses to borrow cheaply in order to innovate and expand. That's a recipe for growth stocks to outperform.
Cybersecurity company Palo Alto Networks (PANW +3.09%), as an example, has been aggressively reinvesting in solutions to protect enterprise clouds, and has been making numerous bolt-on acquisitions to add to its security solutions portfolio. Because cybersecurity is a basic-need service in any economic environment, Palo Alto can still deliver double-digit growth, even during uncertain times.
9. Consider income stocks for a smoother ride
While growth stocks have led the market in recent performance, you should still consider adding stability to your portfolio with dividend stocks. Companies that pay a regular dividend are often profitable, have time-tested business models, and they've historically outperformed their non-dividend-paying peers by a considerable amount over the long run.
Take healthcare conglomerate Johnson & Johnson (JNJ 1.37%) as an example. Over the trailing five years, Johnson & Johnson's performance has ranged from being down 8% to up 57%, which is a pretty tight range, all things considered. Johnson & Johnson benefits from the fact that people don't get to decide when they get sick or what ailment(s) they develop. This creates a steady and predictable stream of cash flow for J&J that's it's pivoted into a 58 consecutive years of dividend increases.
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10. Think long-term
Finally, you have to think long-term if you want to compound your wealth many times over.
There's no question that there's going to be a lot of noise in the short-term from time to time. But in most instances, this short-term noise fades over time. Always remember that operating earnings growth and innovation is what drives long-term valuations, not emotion.
