For many investors, a stock market crash is the last thing on their minds. Markets have rocketed to all-time highs and investors are exuberant at the prospects for a full economic recovery as the COVID-19 pandemic comes under control.
People around the world are beginning to unleash pent-up spending power, and businesses everywhere are looking to take full advantage. And as vaccinations proceed across the globe, those positive trends are building momentum. It's a time of hope for all.
Yet it's at times of maximum positivity that investors should look at what they'll do if things reverse course quickly. Fortunately, in most cases, you don't have to take drastic action to protect yourself against the next stock market crash. In fact, one simple thing is all it takes to get yourself in a mindset that could weather the next downturn -- whether the crash comes next week, next year, or far from now.
What not to do
First, though, let's get one thing straight upfront: You can't avoid the next stock market crash. The costs of missing out on the stock market's long-term gains are too great to risk missing out based on predictions that a crash will happen at any specific time.
It's far too easy to come up with smart-sounding arguments for why a stock market crash is imminent. Consider just a few examples:
- A year ago, as the stock market was beginning one of the most impressive rallies in its history, it was easy to believe that the gains were unwarranted and that a second stock market crash would follow the first. It didn't.
- As autumn started and the elections loomed, a market crash almost seemed justified, given all the uncertainty. It didn't happen, as the minor correction instead led to further gains.
- Nearly unprecedented unrest in Washington in January threatened the underpinnings of the American social contract. But the stock market was unfazed, and indexes moved higher.
Many are now pointing to inflationary pressures as the cause of the next crash. Yet that still hasn't stopped the market from climbing to new records.
The 1 question to ask yourself
If you can't avoid the next stock market crash, then what should you do? The answer is simple: Ask yourself whether you own any stocks that you won't want to own if they fall 50%.
Stock market crashes are painful enough if you just own index mutual funds or exchange-traded funds. For those owning individual stocks, they can be devastating. A modest 10% correction in the broader market can send some market-sensitive stocks down 25%, 40%, or even 50%. Often, the fears that send those stocks lower have nothing to do with their underlying businesses. Instead, stock drops can simply be a result of the loss of bullish sentiment among short-term traders in the stocks.
If you don't have the conviction to hold onto a stock if it falls 50%, then you should seriously consider why you own the stock at all. For companies you truly believe in, a 50% drop in price would seem like a huge bargain opportunity to add to positions. At the very least, having enough confidence in your stock selection to hold on through bad times is essential for those with a long-term investing mindset.
A smart rebalancing
What you'll probably find when you go through this exercise is that there are some stocks you feel more confident about than others. If that's the case, you might want to sell your lower-conviction picks in favor of reinvesting in those higher-conviction stocks. Alternatively, you could sell to raise cash in the hopes of picking up shares of better stocks at a discount if a crash does come sooner rather than later.
Investing in stocks is a constant struggle between trying to make the most during good times and losing the least in crashes and bear markets. The best strategy acknowledges that top stocks are well-suited to both market environments and will stand the test of time. If you already have those top stocks in your portfolio, you'll likely find that you don't have to do a thing about a looming stock market crash.