Many investors are concerned that a downturn is bound to hit the stock market in the next year. Major stock indexes are near all-time highs, valuation ratios are above historical averages, and interest rates look set to rise, pulling capital away from stocks. There are certainly risks swirling around right now, but the right investment strategy will keep you from sweating a potential stock market crash.
1. The next crash might be a long way off
This isn't the first time that investors have been worried about a crash. Sometimes, those concerns are warranted. The dot-com bubble and the global financial crisis were two incidents that some people saw coming, and it seems obvious that the stock market would tumble in both cases.
However, there have been plenty of times that threatening situations did not culminate in a market crash. The Eurozone crisis, a double-dip recession, and the "Taper Tantrum" made ugly headlines from 2010 through 2014. Investors were still licking their wounds following the 2008 market crash, and ominous signs made it seem that another steep drop was imminent.
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That crash never came. The global banking system slowly regained stability, the Fed slowly raised rates without any major issues, and the U.S. economy notched several years of growth. It wasn't always smooth sailing for the S&P 500, but the stock index averaged 13.4% annual returns from 2010 through 2014.
Missing out on a few years of stock market growth prior to a crash could do more damage to your portfolio than the crash itself. Don't lose sleep over every scary headline, and stay invested for the long haul.
2. Markets rise over the long term
Stock market crashes are scary, and they're inevitable. Fortunately, they're only short-term disruptions. Historically, the stock market has climbed higher as the global economy has grown. Bear markets are only temporary diversions from a long-term upward trend. Even if you bought an S&P 500 index fund at the absolute worst time before the 2008 market crash and sold at the bottom of the Q1 2020 crash, your investment still more than doubled.
A long-term investing approach helps remove some of the sting from crashes and corrections. If you're prepared ahead of time for the bad days, you'll have a healthier reaction to market downturns. Realistically, lower stock prices create an opportunity for investors to buy shares at a discount. If you aren't forced to sell in a downturn, you won't realize those losses -- they're only on paper.
Obviously, not everyone has identical time horizons. Some people, such as retirees, have immediate needs from their investment accounts. That means that they can't have the same cavalier attitude toward temporary losses and volatility.
Luckily, there are proven methods for managing volatility and achieving positive returns in any market condition. Bonds and dividend stocks are two popular tools for limiting the downside of investments.
3. You can still get returns when the stock market is down
Investment portfolios can still deliver positive returns even if the market crashes. Investors generally add more bonds to their portfolios as they approach and enter retirement. Bonds fluctuate in value, just like stocks, but they tend to fluctuate less. Moreover, their prices usually aren't correlated to stock indexes. Bonds also produce interest income at regular intervals.
Dividend stocks also produce income regardless of what stock prices do. Many companies return cash to shareholders in the form of quarterly or monthly dividends, and these distributions typically continue even in downturns. Dividend Aristocrats, REITs, and MLPs are popular choices for income investors. If your stock portfolio creates income, you can use those cash flows to reinvest or pay your bills.
A balanced allocation strategy means that your portfolio will perform even if the market crashes. Income can keep you afloat while you wait for growth to resume.
