It’s every investor’s worst nightmare. You wake up in the morning, check the news and bam! There’s been a stock market crash. This may leave you momentarily crying into your bowl of cereal. But a market crash or correction is not always a bad thing. It’s a natural part of investing.
Here are my thoughts on whether we’re due a pullback in the market. And more importantly, what you can do to prepare for such an event.
[top_pitch]
What is a stock market crash or correction?
A stock market crash is a fast and steep reduction in the total value of a market. Whereas a stock market correction tends to be a smaller and less severe drop.
When this happens, the impact means a sell-off in shares. This selling of investments creates a downward spiral that results in less money floating about the market. During a market-wide crash or correction, you’re likely to see the ‘paper value’ of your investments fall.
So you only ‘lose’ money on paper. But if you sell your investments at their new lower valuation, you’ll get less for them than you would have pre-crash.
Why might we be due a market drop?
A stock market crash or correction is inevitable. It’s a case of ‘if’ rather than ‘when’. Other than the flash-crash in March 2020, we’ve been swirling around in a bull market for years. As a result, many investors believe that some sort of cooling-off is long overdue.
Because of the coronavirus pandemic, a lot of weird and wonderful things have happened in the markets. Many fear that the stock market is bloated. This means there’s been lots of money flowing into markets because investors have had limited options.
If you’ve been able to cut costs during the pandemic, you may have found yourself with more spare cash. Even the best savings accounts pay low interest rates, and so the consensus has been to put that money into stocks and shares.
Will there be a stock market crash in 2021?
This is the million-dollar question. Putting an exact timeframe on these kinds of things is impossible. If you knew exactly when a crash was likely, you’d stand to make a lot of money!
However, it does seem like many investors are expecting some sort of pullback in the markets. This general feeling amongst investors can create a self-fulfilling prophecy. People get extra-sensitive and look for reasons to pull their money out of the market.
This kind of erratic behaviour is silly, but what can you do? Right now, the market seems to flinch with any piece of news. My view is that there could be a drop in the stock market before the end of the year, but only if there is some significant bad news or a global event.
If you’re a long-term investor looking to build wealth, you need to realise two things:
- A stock market crash or correction is not the end of the world and markets tend to recover over time.
- These events can provide excellent opportunities if you buy shares on a regular basis.
[middle_pitch]
How do I prepare for a market crash?
Trying to time the market is a fool’s errand. Pulling out all your money today means you could miss out on some big gains over the next few months or years if no dip occurs.
The best thing to do is:
- Prepare yourself mentally to stay calm and collected if the value of your investments goes down
- Make sure you have a diversified portfolio of shares – this will help to minimise any potential losses
- Try and hold a variety of assets so that you can ride out any turbulence
- Be sure to have some savings and an emergency fund regardless of what is happening in the market
Can I take advantage of a stock market crash?
Yes! Those in the know realise that a crash or correction is similar to a sale! You can buy shares and other assets at a lower price than they previously were.
So if values drop, keep your cool and stick to your plan. By investing consistently through down periods, you’ll benefit from ‘pound-cost averaging‘.
If you do have spare money, it can also be a good opportunity to grab some bargains. Just remember that all investing carries risk and there are no guarantees. So be prepared for the fact that you may get out less than you put in.
