In every economic cycle, there are moments when at least some commentators expect a stock market slump. Sooner or later it always comes. But sometimes it is years or even decades before it happens. If anyone knew with certainty when the stock market will next crash, it wouldn’t function efficiently as a market. While many investors have highly informed opinions, that’s all they are. The fact is, no one knows with certainty what will happen to the stock market in future.
With that in mind, and knowing that the stock market will slump eventually, here’s what I do to stay prepared.
Focus on value, not price
When buying shares, I look for value. As Warren Buffett says, “Price is what you pay, value is what you get”. Value for me is being able to buy a portion of a company which I think has strong long-term growth prospects, at an attractive price.
So I try to avoid situations where a share looks cheap but the company isn’t that attractive to me. I also try to avoid situations where a share price is driven mostly by momentum, like meme stocks. That isn’t investment, it’s speculation.
By buying shares I think are good value, I don’t need to worry about the short-term gyrations of the market. Consider Unilever as an example. Its strong brand portfolio gives it pricing power. Its global reach offers strong revenue growth potential. There are risks – for example, an economic downturn could affect consumers’ willingness to spend, and hurt profits. But a stock market slump doesn’t alter the value of the Unilever business in my view. The shares could fall – but the business would still be worth the same. So I’d see it as a buying opportunity, because over time the market would likely rebalance and like any other company, the Unilever share price would tend back towards its underlying value.
A shopping list for a stock market slump
It’s because of the wild price aberrations that a stock market slump can throw up that I keep a shopping list for just such an occasion. On my shopping list are companies I think are attractive because they have strong business prospects. Some of them I would buy at today’s prices, while others I currently see as overvalued. But for all of them I like the underlying business prospects.
If the stock market slumps, it will give me a buying opportunity to get into these shares at a very attractive price level. That could significantly boost my long-term returns.
Developing an investment mindset
A stock market slump can be very scary for many people and understandably so. That’s why I consider it important to go into any crash with the right frame of mind. I want to avoid rash or undisciplined decisions.
To do that, it helps to develop a way of thinking ahead of time that one can stick to even during a dramatic stock market crash. Speculators may move in and out of shares rapidly just to exploit price differences – but investors don’t. Investing is about research, judgment, patience, and consistency. Those aren’t attributes one can instantly develop in the middle of a stock market slump. Instead, applying them consistently when the market is doing well sets me up to behave consistently whenever it crashes.
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Christopher Ruane has no position in any shares mentioned. The Motley Fool UK has recommended Unilever. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.