They say there’s no such thing as a guarantee when it comes to investments. I beg to differ, another stock market crash is guaranteed to happen. I don’t know when it will happen, nobody does. I do know, however, that it WILL happen at some point.
How you react when it happens can have a profound impact on your financial future.
If you stay calm and stick to your investing principles, it will help accelerate your path to financial independence. If your emotions grab hold, causing you to panic, it can set you back years.
Think of it as a test, one that can be worth thousands, even millions of dollars over the long run.
As with any other test, taking the time to prepare yourself is an absolute must if you want to do well.
I’m guessing that you are a somewhat educated investor when it comes to stocks. If not, JL Collins’ Stock Series is a great place to start. JL, like many others in this space, is a staunch advocate of the buy and hold investment strategy using low cost market index funds. Buy as much as you can as often as you can and then forget about it for a long time. The longer, the better.
This is a really solid long term strategy. Let’s say you invest in low cost vehicles like VTI or VTSAX over a 40 year period. History shows that this path is as good as guaranteed to make you rich. Assuming the American Economy doesn’t completely collapse and never recover, you will end up far ahead of where you started, likely very very far ahead.
While this strategy is rock solid, executing it isn’t always so easy. Emotions can wreak havoc on this strategy if you aren’t prepared to deal with them. Staying calm during a market crash is hard. Not selling stock is hard when you are watching your net worth fall day after day after day.
There’s a ton of evidence that shows people who try to time the market actually end up significantly underperforming the market. In order to time the market successfully, you have to be right twice. You have to sell when prices are near the peak, and then buy in again before prices go up too high. Get it wrong on either end, and you’re going to get burned.
When times are good, a.k.a. right now, it’s easy to be an investor. Eight years ago, a monkey could have thrown a dart at a page of mutual funds and doubled or tripled his money by now.
Many people in the FIRE community started their journey after the 2009 crash, which saw a +/- 50% decline. Almost every single article that you have read about Personal Finance in the last 8 years was written during a bull market.
We’ve read stories about people who hit their FIRE number early, which is awesome and inspiring. It’s important to understand that all of them were riding an extended bull market, which helped enormously.
I’m not trying to diminish anyone’s achievements, making it to Fi should always be celebrated, bull market or not. That said, it’s not always going to be this good. Many of us might not hit our number on schedule, let alone early.
I’m a gen x-er, so I’ve been through a couple of decent sized crashes in my investing lifetime. I’ve tried timing the market before, the results were miserable. I sold during the 2000-2002 crash, then held cash until things went back up, buying in again during 2006-2007, only to watch it all tumble right back down a couple years later. This is a classic example of how you can significantly underperform the overall markets, even if you’re invested in index funds.
I’d like to think that I’m a little older now and I know better after this experience, and the reality is that I do know better. I’d also like to think that I’ll be able to resist the temptation to do it all over again the next time the bear market comes around.
Here’s the problem, it’s really freaking hard to keep your emotions in check and sit idle as you watch everything you’ve earned crash and burn by 30%, 40%, or even 50%+. If you haven’t been through it, you don’t know how hard it is.
That’s why it’s essential to prepare yourself!
Preparing yourself for the next market drop might be one of the best decisions of your financial life. I did not prepare myself before the last big crash. I had a couple thousand dollars invested in 2000, less than 1% of what I have now. It was too hard for me to handle, I panicked and lost a huge percentage of my investments.
I’m not making that same mistake this time around. Here are some steps that can help you be better prepared to do the same.
Finding my risk tolerance
For perspective, My current goal is to hit $3,000,000 in liquid investments. I have a long way to go. I’m at roughly $860,000 at the time of this writing. Up until a couple of weeks ago, I was 100% in stocks. Most of my liquid investments are index stocks (VTI and similar). I do still have some individual stocks that have large unrealized gains, so I’m leaving those alone for now to avoid the taxable event of selling them.
My goals is to reach Fi in 5-10 years. I do have some flexibility in my spending by pulling some lifestyle levers to reduce my time to Fi.
Because I’m somewhat close to Fi, I’m in no way, shape, or form mentally prepared to lose 30-50% of my liquid investments. I’ve literally kept myself awake at night wondering when the crash will come. The days that the market loses 200+ points, I think, “uh-oh, is this it”. I’m also a wee bit neurotic when it comes to watching the markets, like I check them multiple times a day. That’s a topic for another day…
Now, I’m not convinced that the markets are going to drop anytime really soon. We’re in a strange point in time where deregulation combined with government intervention is pushing us into uncharted territory. Historical performance indicators may not be as relevant as they have been previously.
At the same time, I’m not ignoring the fact that the current valuations of the equities markets are off the charts high right now from a historical perspective. I’m also aware that bonds have a risk/reward profile that doesn’t look attractive or safe to me right now with interest rates and yields being historically low.
I’ve come to grips with the fact that this means I’m not someone who should be 100% in stocks and bonds right now. I know being in lower yield investments like annuities or cash alternatives comes with it’s own risk, the inflationary risk. I’m totally okay with that.
I’ve always been a saver, and I always hated losing money, even in the short term. The risk of lost opportunity cost is something I’m prepared to deal with right now in exchange for a little more security.
To that end, I’ve converted 25% of my portfolio to low upside investments. I know this might mean that I reach Fi later, and ultimately have less money in 20+ years. I also know, that I’m now better protected from a big time crash if it comes along before I reach financial independence. I’ve made peace with that. I sleep better at night now.
So my suggestion is to figure out when you need the money, and adjust your plan accordingly.
If your current allocations keep you up at night or make you constantly nervous, you should consider changing it. Constant stress will erode your quality of life over the long term. Find a mix that allows you to forget about your investments, or at least the stressful part of the equation.
Don’t underestimate the impact of this. I am so much less stressed about the markets now that I’ve adjusted my allocation. Does it make sense in the 20+ year horizon, probably not. Does it make sense for my stress reduction right now, absolutely it does. Find the mix that’s right for you.
Disrupt the potential path to panic selling
If possible, check the markets less. If you don’t know the market is going down, you won’t have the urge to sell.
Set it and forget it. Setting up auto investing straight from your paycheck or bank account is a great way to limit your exposure to your trading platform. I’ve heard of people who only allow themselves to sign into their accounts once a quarter, or even every six months.
Once you have allocated your investments mix to match your risk tolerance, there’s really not much good that can come from frequently monitoring your portfolio. It’s a waiting game at that point, go enjoy life.
Make a password that reminds you not to panic – if your password was Dontpanicsellin2017! It could serve as a reminder every time you log in. Every time you log in to your accounts it would reinforce you need to stay calm when it’s needed. For this to work well, you’d need to not save your passwords automatically in your browser and apps. Yes, this is a minor inconvenience, but c’mon, how many thousands is typing a password worth?
Two factor authentication – this is another way to give yourself another barrier between you and a panic initiated selling spree. Most financial tools will allow you to set this up as an option.
None of these steps are all that hard to do. None of them are guaranteed to work, obviously. But each of them will help you be a little more prepared when it’s test time. If you have other ideas, I’d love to hear them in the comments.
Thanks for reading!