Enduring a stock market crash is something most investors will eventually have to do. And it can be scary for first-time investors and seasoned experts alike. We’re currently experiencing a taste of that with the current market turmoil.
And we get it – it’s natural to worry about what’s coming next and what it could mean for your investments. But this is part of the investing game, and it won’t last forever. We’re with you.
Now let’s look at what is actually happening in the market, and what you can do to prepare.
Is the stock market going to crash?
It’s hard to predict what the stock market is going to do. But we can take a look at what’s happening in the present and understand what factors contribute to market volatility to better understand what the future might hold.
Since the start of 2022, the FTSE 100 has basically not moved. But the same can’t be said for investors across the pond. The S&P 500 along with the Nasdaq have fallen by double digits, with the latter almost hitting a 30% decline!
Technically speaking, the current situation is a correction rather than a crash. But that doesn’t mean it might not turn into a crash in the future.
With that in mind, let’s explore the topic in a bit more detail.
Why would a market crash?
Looking throughout history, stock market crashes have been triggered by various unique reasons. In the late 90s, investors realised that internet companies weren’t living up to the hype. In 2008, a housing crisis started in the US before spreading worldwide. And in 2020, a pandemic came along and shut down almost every economy on the planet.
What about today? We seem to be facing a whole bunch of problems at the moment. To name a few, there’s sky-high inflation, rising interest rates, labour shortages, supply chain disruptions, continued Covid-19 lockdowns in Asia, and an energy crisis in Europe. All these factors are dragging down economic growth. And now, fears are circulating that another recession could be on its way.
Let’s take a step back for a moment.
It’s important to remember that a recession is a worst-case scenario. No one really knows whether it will happen, let alone to what degree of severity. It’s the uncertainty that is driving stock prices down.
RELATED: When Will the Stock Market Recover?
How to prepare for a stock market crash
Fortunately, an investor can take plenty of steps to prepare for this worst-case scenario.
1. Make sure your emergency fund is up to scratch
A golden rule of investing is to only buy shares with money you don’t need. And a stock market crash is a perfect demonstration of why this rule exists.
The last position any investor wants to find themselves in is being forced to sell shares in fantastic businesses when prices are low. Running out of cash for everyday expenses and other financial obligations can severely undercut the long-term performance of a portfolio. And it can add years to your journey of finding long-lasting financial success.
That’s why it’s essential to have an emergency fund to eliminate this risk, especially during a stock market crash.
So, how big should this emergency fund be? There is no one right answer to this question. It’s entirely dependent on personal financial circumstances. But a ballpark figure is around six months’ worth of savings stashed away for a rainy day.
2. Stay invested, stay diversified
Providing that your portfolio contains stocks with strong underlying businesses, chances are the prices will eventually make a full recovery and then some. That’s why staying invested even through a painful market crash is a critical first step.
But stock recoveries are never guaranteed. And depending on the circumstances of the underlying business, a plummeting share price may never reverse.
Diversification is a powerful risk-reduction tool at your disposal. By not putting all your eggs in one basket, the damage caused by a failed business is mitigated by other positions in stronger companies.
With that said, how many stocks should you own? Once again, this is ultimately down to personal circumstances. But here at The Motley Fool, we advocate for around 25 different companies in a variety of industries.
3. Remain focused on the long term
Getting hung up on short-term volatility is quite an easy mistake to make. After all, watching a stock collapse by double digits for seemingly no reason is not pleasant. But when taking a long-term investing perspective, these price slashes can end up looking like tiny blips in an upward journey.
Saying this is one thing. Doing it is another. Keeping a cool head and a strong stomach when times are tough is challenging to say the least, especially for newer investors going through a crash for the first time.
But keep in mind that the stock market has a perfect track record for making full recoveries from stock market crashes. And it’s extremely unlikely for that pattern to change in the future.