January's market sell-off served as a stark reminder that stocks can go down as well as up. Smart investors recognize that reality and have plans in place to effectively manage their money when the market moves against them. No investor can completely avoid a crashing market, but those who are prepared can often emerge in a stronger position once it passes.
With that in mind, we asked three seasoned investors for ways to save your portfolio when the market crashes. They shared their strategies of buying more when stocks were down, relying on strong dividends, and managing a bond ladder to make it through the volatility. Read on to learn more about their strategies and determine if one or more of them might be a good fit for your market crash defense plan.
Image source: Getty Images.
Don't panic sell -- buy, instead
Barbara Eisner Bayer: How do you feel when the market tanks and your portfolio starts crashing? Day in, day out -- every time you look at your life's savings, they're sinking lower and lower.
How have you reacted so far in 2022? Are you one of those people who feels the pit in their stomach? Or perhaps you're someone who runs to push the sell button to lock in the profits you've accumulated to guarantee you won't lose any more.
As of Feb. 8, popular stocks like Moderna, PayPal Holdings, and Meta Platforms are down 39.64%, 36.23%, and 34.54%, respectively, since the start of 2022. I feel sick to my stomach just looking at these!
But don't just panic sell your thoughtfully purchased stocks. Consider this: In 2017, after eight years of the bear market, the big tech stocks Meta, Amazon, Netflix, and Alphabet gained 1,200%, on average. If you had $100,000 invested in those stocks and held them instead of panic selling, that money would have been worth $1.3 million dollars in 2017 -- and even more today. Had you panicked and sold, they would be worth zero.
As long as you don't sell a stock, you won't lose anything. The fact is that the stock market has always recovered from a crash or correction -- it just takes a little bit of time. So it doesn't make sense to sell when there's a market pullback.
There is something that does make sense, however -- and that's to purchase stocks that have been severely hit. In order to be prepared to do that, you need to do three things:
- Make a list of stocks that you'd like to buy if there's a market correction.
- Accumulate cash in your brokerage account so you can strike when the moment is right.
- Don't be afraid to pull the trigger when the stocks on your list are down.
Buying when stocks are being sold in a frenzied way will ultimately save your portfolio, since history has shown that the market always recovers. Hold on to your current stocks and buy new ones as the opportunity presents itself. Then, in a year or so, you'll look back and be rejoicing about how savvy an investor you were.
The dependable dividend defense
Eric Volkman: A good dividend stock stands a better chance of making it through a crash than many other assets -- rival classes of stocks included.
There are two major reasons for this. First, and perhaps most importantly, with a steady dividend payer an investor is assured an income stream. And what's better than a bit of regular income through a nervous, unsteady time?
Second, investors who still have a little bull in them will gravitate toward such stocks. To begin with, that dividend helps support the price of the shares (see the paragraph above). Also, keep in mind the most popular dividend stocks got that way because their companies learned how to generate significant amounts of cash on a regular basis. Yes, even through scary market dives.
As such, for many investors, the top dividend stocks are "break glass in case of emergency" fail-safes.
History reveals just how resilient many of these investments have been. Let's look at three Dividend Aristocrats (i.e., S&P 500 index component companies that have enacted dividend raises at least once a year for a minimum of 25 years) -- fast-food behemoth McDonald's, spice and condiments specialist McCormick, and drink and snack master PepsiCo.
From 2000 until now -- a time span that covers the late 2000s financial crisis -- McDonald's total return (share price appreciation plus dividends) has eclipsed 1,000%. To put it gently, that's quite some distance better than the S&P's 207% growth over the same span.
Yes, yes, McDonald's is a hot stock now, but we can't say PepsiCo or McCormick enjoys the same status. Yet here they are with a respective 743% and -- wow! -- 2,000% return. Numerous other examples abound.
Now I'm not saying we should plow every penny we have into dividend stocks as we scramble for the bunkers. At least some cold, hard cash is good to have on hand, too, and well-timed buys of unpopular yet quality growth stocks could reap big rewards before long. But those dividend payers really have a way of surviving through the market's tough times, making their investors glad they decided to hold on for the ride.
The name's Bond. Bond Ladder
Chuck Saletta: As a general rule, money you expect to spend within the next five years does not belong in stocks. While low interest rates mean that bonds currently offer a terrible return on investment, they still generally offer better returns than cash and higher predictability and payment priority than stocks. That combination of factors makes a high-quality bond ladder a reasonable tool to use to hold money you expect you need to spend within the next five or so years.
In addition to a reasonable way to hold that nearer-term money, a bond ladder can be a great way to help manage your portfolio when the market crashes. This is because bonds mature and get paid out as cash. You can use that feature to shift your allocation between stocks and bonds without having to predict in advance what the stock market will do.
When the stock market is performing normally, you can use your stock gains to maintain your bond ladder. When the stock market is strong, you can cash out your excess stock earnings and use them to extend the length of your bond ladder. When the market is crashing, you can simply let your bonds mature without buying new replacement bonds. In all cases, you should be able to use the money from your maturing bonds to cover those near term costs you're expecting your portfolio to cover.
By managing your money that way, you "automatically" become more concentrated in stocks when the stock market is down, without having to scare up extra cash to buy new shares. You also get the spending cash you need to last through a fairly protracted downturn without having to sell your shares while they're down. That built-in behavior from a well-managed, high-quality bond ladder is what makes it a great tool to help protect your portfolio overall when the market crashes.
Put your plan in place today
Whatever path you choose for dealing with a market crash, the best time to have your plan in place is before it happens. With the Federal Reserve poised to actually soon begin the tapering it has been promising, there's a chance stocks may be headed into another rough patch. The sooner you know what you'll do when the market moves against you, the better your odds are of having your plan in place before you need it. So get started now, and be that much more ready when the next crash happens.
