A Market Crash Is Coming

I hope this isn't news to you: Another stock market crash is on its way. That's the bad news. The good news is that it isn't necessarily right around the corner. While many financial prognosticators on TV will offer opinions on when the next big crash is due, I don't feel like I'm shortchanging you with my own opinion: I don't know when it will happen. This is the best answer anyone can offer, in fact, since the stock market's short-term movements are extremely unpredictable. (Long term, the arrow has usually pointed up.)

Still, there are some things we can learn by looking at past crashes. At about.com, I recently ran across Dustin Woodard's review of our 10 worst stock market crashes. Here they are:

What to learn from this
How can this information help you? Well, consider these thoughts:

• Regrettably, some of the crashes followed one another quite closely. For example, while the Dow sat near 400 in 1929, it remained below 100 by 1942. One could argue that in this period there was one long crash instead of several small ones.
• A big question the table raises is: What caused this carnage? The answer, unfortunately, is that the reasons have varied over time. The Depression years included several crashes, and there was one during and one soon after World War I as well. Other factors that have been tied to crashes include inflation, speculative trading, insufficient regulation of the market (which has been strengthened over time), automated trading, and trade and budget deficits. Sometimes crashes occur without clear-cut reasons. The 1987 crash (featuring a one-day 23% drop), for example, has many alleged causes, but no one definitive cause that I could find.
• A last thing to notice is that there have always been recoveries, and the market trends upward in the long run. You sometimes have to wait a long time for a full recovery, though. This is especially true for those who invested in market darlings that soared, often unreasonably, prior to crashes. Sun Microsystems (NASDAQ:SUNW), for example, soared from roughly a split-adjusted $5 to more than $60 between 1998 and 2000, and remains well below 1999 levels today.

What to do about it
So, what should you do with this information? Let it shape your investing. Let it be a reminder that anything can happen in the coming five or even 10 years, so you should only have your long-term money in stocks. You don't want to lose that sum you've socked away for a down payment on a house or for college tuition. Here are a few takeaways.

• If you're frightened of any kind of significant drop, you might want to place stop-loss orders for your holdings with your broker. (Learn more about brokerages in our Broker Center.) You can, for example, specify that if Stock ABC falls 10%, you want it sold ASAP. This can protect you, but it can also evict you from some great performers that temporarily slump. (Read Jim Mueller on the dangers of stop-loss orders.)
• Look for opportunity in crashes. If you have some cash on the side, or can generate some, you might be able to take advantage of some first-rate bargains (though, again, it might be a few years until you're rewarded). For example, on Black Monday in 1987, J.C. Penney (NYSE:JCP) stock fell 19%, from about $29 to $23 (which in today's split-adjusted terms would be a drop from $6.24 to $5.04). It gained back that ground within a few months, and it had more than doubled within two years. Recently it was trading around $82 per share, representing a 16-bagger for 1987 investors. Look at Adobe's (NASDAQ:ADBE) chart, and you'll see that investors who bought after the recent Internet bubble burst have done rather well, as have patient Qualcomm (NASDAQ:QCOM) investors.
• Consider investing mainly in certain kinds of companies -- stable growers that pay significant dividends, which you'll receive no matter what the market is doing. Look at this chart of Colgate-Palmolive (NYSE:CL), for example, and see how rocked it was by the 2000 to 2002 market crash. Wells Fargo's chart also shows the value of hanging on to steady growers. Over the past decade, through market ups and downs, Colgate-Palmolive's dividend per share has grown by a compound average annual rate of 10%, and Wells Fargo's has grown by 15%. (Two other high-yield companies worth a closer look are Altria and Dow Chemical (NYSE:DOW), recently yielding 4.8% and 3.7%, respectively.)
• If you're interested in adding some (or many!) significant dividend payers to your portfolio, I invite you to test drive, for free, our Motley Fool Income Investor newsletter. Its recommendations have been beating the S&P 500 by nearly 10 percentage points on average. A free trial (no obligation to subscribe) will give you full access to every past issue.

Here's to doing well through the coming crash!

This article was originally published on March 21, 2007. It has been updated.

Longtime Fool contributor Selena Maranjian doesn't own shares of any company mentioned in this article. For more about Selena, view her bio and her profile. Colgate-Palmolive is a Motley Fool Inside Value recommendation. Dow Chemical is a Motley Fool Income Investor recommendation. The Motley Fool is Fools writing for Fools.