The stock market has rebounded sharply off its March lows, with the S&P 500 rallying by nearly 40% in just over three months. Businesses are reopening across the U.S. and economic data has been generally stronger than expected, especially when it comes to unemployment and consumer confidence. Because of this, it may feel like the worst is definitely behind us and the 2020 market crash is a thing of the past.
This may certainly be the case, but we're not quite out of the woods yet. As you've probably seen, COVID-19 cases have been spiking in many parts of the United States in recent weeks, and several states have decided to roll their reopening plans back. So far, this has only mainly affected certain high-contact businesses like bars and restaurants, but if the outbreak isn't brought under control we could see further action taken.
Also, don't forget that second-quarter earnings season is coming up, and the numbers aren't likely to be pretty. There's also the upcoming elections, the trade war with China, and several other things that could turn into negative catalysts for the stock market.
The point is that we're not out of the woods just yet with the COVID-19 pandemic, and the stock market could definitely take a downward turn again before 2020 is over. As Warren Buffett once said: "Predicting rain doesn't count. Building arks does." In other words, we know that the market will crash sooner or later, but it's not enough just to know it's going to happen -- you have to make a plan. With that in mind, here are three ways to make sure you'll be ready if it happens.
Invest over time, not all at once
One of the best principles investors can implement, especially if you're worried about a market crash, is to build your positions over time instead of all at once.
Dollar-cost averaging is a smart way to do invest in stocks. This essentially means investing equal dollar amounts in a stock at specified intervals – for example, instead of putting $2,000 in a stock all at once, you might decide to invest $500 per month for the next four months instead. This way, if the stock market crashes or your stock goes down, you'll be able to take advantage of the lower prices. And if your stocks go up before you make subsequent investments, you'll have bought more of your shares at lower prices.
If you have your eye on a stock and put all of your money into it right away, a market crash can be a nerve-racking time. On the other hand, if you decide to average into positions over time, a crash can end up being a welcome opportunity.
Focus on quality
There's no such thing as a crash-proof stock portfolio. In March when the market was in free-fall, even the best companies' stocks were getting crushed.
However, there are such things as crash-resistant businesses, and if your goal is to prepare for a potential market crash while still setting yourself up for strong long-term growth, focusing on top quality companies when you invest in the stock market is one of the smartest things you can do.
While there's no set-in-stone formula that separates out the high-quality companies, here are a few questions to ask to help make the determination for yourself:
- Is this company the leader in its industry or niche, or close to it?
- Does this company have a strong balance sheet with financial flexibility and a manageable debt load?
- Does this company have a durable competitive advantage that should protect its business?
As an example, Apple (AAPL 2.11%) is the largest stock position in my own portfolio, and quality is a big reason why. Apple is an industry leader, has a twelve-figure cash stockpile on its balance sheet, and its loyal customer base and tech "ecosystem" helps keep its sales high during tough economies.
Keep your long-term strategy in focus
Finally, one of the best ways to plan for a market crash is to realize that a crash is a short-term event and that you're a long-term investor. When the market took a beating in March, the most common question I got was "What should I do with my 401(k)? Should I sell my investments before things get worse?" And my answer was "Are you planning to retire in the next year or two?" If the answer was no, the best course of action is to do nothing at all – and since the market has rebounded by about 40% since then, my hope is that they listened to me.
The point is that the investments in your 401(k), as well as the stocks and funds you own in your brokerage accounts are long-term investments and it's important that you treat them that way in good times and bad. Don't pay too much attention to short-term price movements in either direction -- simply buy great businesses and keep them for as long as they remain great businesses.