Statistically, the stock market goes through crash (a drop of 30% or more) once every 12 years. And every time the stock market goes through one of these, it recovers over time. That means that, as an investor, I probably don’t need to worry much about the market crashing. It’ll probably happen at some point, but things will likely work themselves out as long as I concentrate on making sensible investing decisions.
That said, there are some things that I can do right now to prepare myself for a stock market crash. The first is making sure that I have a long-term focus. The second is keeping enough cash on hand so that I’m not forced to sell my investments at the wrong time. The third is focusing on my investments as businesses, rather than stocks. All of these are things I can do today to prepare for a stock market crash.
After every stock market crash, there has always been a recovery. This means that, if I can wait long enough after a crash, I’ll be okay. Ultimately, if I buy Unilever shares today at 3,440p and sell them after 20 years at 4,800p (collecting dividends along the way), it doesn’t matter what price they traded at in between. Whether they went in a straight line from 3,400p to 4,800p or whether they fell to 1,670p and then made their way back up, the end result is the same. Keeping a long-term focus means not worrying about a stock market crash because the prices in the short term don’t matter.
Securing personal finances
In order to maintain a long-term focus, I need to make sure that I’m not forced to sell my shares any time soon. I need to be in a position such that I have enough cash available to get me through whatever happens in the near future. If I don’t do this, I might have to sell an investment at a low price to pay for something immediately. In that situation, a stock market crash would give me a problem. In other words, having an emergency fund prevents this and allows me to not worry about the price of my shares because I don’t need to sell them.
Focus on businesses
The third thing that I can do to prepare for a stock market crash is focus on owning businesses, rather than stocks. This means measuring the return on my investment by how much the company makes, not how much the stock moves. For example, with British American Tobacco, the company’s stock is down from where it was 10 years ago. But the company has increased its earnings per share over that time. A market crash is just a reminder that share prices don’t always follow business returns perfectly. By looking to the underlying business, rather than the stock, for my investment return, I can see that a stock market crash is just a temporary issue.
I don’t know when a stock market crash will come. But whenever it does come, I’ll be prepared.
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Stephen Wright owns shares in Verizon. 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.