Investing is a continual learning process. And we often tend to learn the most during moments of market turbulence. It’s easy to make money when the stock market is rising, yet when the market crashes, we tend to learn a whole lot more about fundamental issues such as risk management and portfolio construction.
With that in mind, today I’m looking at three important lessons investors can learn from the recent market crash that has seen the FTSE 100 fall over 8% in less than a month.
Keep cash on the sidelines
One thing I often tell people is that it’s important to have some cash available on the sidelines that is ready to deploy when opportunities arise. This is particularly important when markets have had a strong run and are trading at relatively high levels, as they have been in the recent past.
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All too often, novice investors commit all their capital to the market in an effort to maximise their gains. The problem with this approach is that when the market pulls back by 10% to 20% (as it often does) and there are bargains on offer, the investor will have no money left to capitalise.
Keeping some powder dry gives you valuable options. It enables you to take advantage of stock market weakness and buy stocks at lower prices while other investors are panicking. This can really boost your performance over the long run.
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Another sensible investing habit is to drip feed money into the market continually throughout the market cycle, instead of just dumping a lump sum into the market at a specific time.
Often, when investors decide to dive into the stock market, they’ll invest all their money at once (often at exactly the wrong time too). The problem with this strategy is that if markets then crash, the investor will be looking at a significant paper loss, which can be incredibly frustrating and take its toll emotionally.
A better idea is to invest a little each month, or perhaps each quarter. That way, if the market does pull back, you’ll be able to pick up shares at lower prices.
Diversify properly
Lastly, the recent market crash has been a reminder that it’s always important to diversify properly, and that means owning a variety of stocks or funds across different sectors, geographic regions and market capitalisations (large-, mid- and small-caps).
While the recent market crash has seen most stocks decline, some areas of the market have been hit worse than others. For example, many UK small-cap technology stocks have fallen by 30% or more in the last month. So, if your portfolio was only invested in this area of the market, it’s likely that its value would have taken a large hit. However, other, more defensive areas of the market have not performed as badly during the recent market volatility and therefore could have provided an element of portfolio protection. Spreading your money out over a variety of different investments is one of the easiest and most effective ways of reducing overall portfolio risk.
It’s easy to make mistakes when investing. Often, these mistakes become more pronounced when stocks are falling. The key is to learn from your mistakes so that you’re better prepared for investing success in the future.
