Many investors fear that a downturn will hit the stock market next year. Major stock indexes are near all-time highs, valuation ratios are above historical averages, and interest rates are expected to rise, pulling capital away from stocks. There are certainly risks swirling around right now, but the right investment strategy will keep you from sweating a possible stock market crash.
1. The next crash could be far away
This is not the first time that investors have worried about a crash. Sometimes these concerns are justified. The dot-com bubble and the global financial crisis were two incidents some saw coming, and it seems obvious that the stock market would crash either way.
However, there have been many times when threatening situations have not resulted in a stock market crash. The eurozone crisis, a double dip recession and the “Taper Tantrum” made headlines from 2010 to 2014. Investors were still healing their wounds after the 2008 stock market crash, and there were worrying signs that another brutal fall was imminent.
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This crash never happened. The global banking system has slowly regained its stability, the Fed has slowly raised rates without major problems, and the US economy has experienced several years of growth. Navigation has not always been easy for the S&P 500, but the stock index posted average annual returns of 13.4% from 2010 to 2014.
Missing out on a few years of market growth before a crash could do more damage to your portfolio than the crash itself. Don’t lose sleep over every scary headline and stay invested for the long haul.
2. Markets increase over the long term
Stock market crashes are frightening and inevitable. Fortunately, these are only short-term disruptions. Historically, the stock market has climbed higher with the growth of the global economy. Bear markets are only temporary deviations from a long-term uptrend. Even if you bought an S&P 500 index fund at the worst time before the 2008 stock market crash and sold at the first quarter 2020 crash low, your investment still more than doubled.
^ SPX data by YCharts
A long-term investment approach helps remove some of the sting of crashes and fixes. If you’re prepared for bad days ahead of time, you’ll react healthier to market downturns. In reality, lower stock prices create an opportunity for investors to buy stocks at a discount. If you don’t have to sell in a downturn, you won’t realize these losses – they’re just on paper.
Obviously, not everyone has the same time horizons. Some people, like retirees, have immediate needs from their investment accounts. This means that they cannot have the same cavalier attitude towards temporary losses and volatility.
Fortunately, there are proven methods to manage volatility and achieve positive returns in all market conditions. Bonds and dividend-paying stocks are two popular tools for limiting the downsides of investing.
3. You can still get returns when the stock market is going down
Investment portfolios can still generate positive returns even if the market collapses. Investors typically add more bonds to their portfolios as retirement approaches. Bonds fluctuate in value, just like stocks, but they tend to fluctuate less. In addition, their prices are generally not correlated with stock market indices. Bonds also generate interest income at regular intervals.
Dividend stocks also produce income regardless of what the stock prices are doing. Many companies return money to shareholders in the form of quarterly or monthly dividends, and these distributions usually continue even in a downturn. Dividend aristocrats, REITs, and MLPs are popular choices for income investors. If your equity portfolio is generating income, you can use that cash flow to reinvest or pay your bills.
A balanced allocation strategy means that your portfolio will perform well even if the market collapses. Income can keep you afloat while you wait for growth to resume.
