Will the stock market crash again? | Smart Change: Personal Finances
Between war in Europe, inflation in the United States at its highest level in 40 years and safeguards at ports disrupting supply chains, investors have plenty to worry about right now. Any of these issues could cause turbulence in the market. All three together provide a key reason why investing has felt a lot like walking on eggshells lately, even as the market made a small comeback in March.
In this context, the answer to the question of whether the stock market will crash again is simple. Yes – it will still crash. The real questions, however, are “when will it crash?” and “what can you do about it?”
The hardest question – when will the market crash again?
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While it wasn’t really hard to predict that 2022 could turn out to be a tough year for the market, one of the main reasons the stock market is open most weekdays is that no one really knows what will happen. The buying and selling of stocks drives market moves – and the emotions of the day can rule long-term fundamentals for a while.
This makes predicting the next stock market crash good for generating clicks, but not so good when it comes to trying to make changes to your portfolio. just before this accident occurs. If you get it wrong and the market continues to rise, you will miss out on big gains. Even if you guessed correctly, you will likely be exposed to a large tax bill. This could take away a lot of the money you’re trying to protect in the first place.
Even predicting when the market will crash again is a very difficult thing to do, recognizing this it will collapse at some point still provides a very valuable investment framework. By planning around this distinction between whether and when a crash will occur, you can find an equilibrium point that works in most market conditions. Essentially, with a decent strategy, you can set yourself up to take advantage of long-term growth while protecting yourself from the short-term pain that crashes bring.
What can you do about a market that is going to crash at some point?
Since you can be sure the market is going to crash, but you don’t know when it will, you need to organize your finances so that you don’t have to depend on stocks to cover your short-term costs. This means that you will need an emergency fund for three to six months to cover your expenses temporarily if your other sources of income unexpectedly dry up. It also means that you will want about five years of the expenses you expect your portfolio to pay to be held in safer investments than stocks.
That doesn’t mean five years of your total living expenses – unless you really plan to cover 100% of your expenses from your wallet. If you expect a pension, social security, salary, or other fairly reliable source of cash to cover some or all of your costs, you don’t need this five-year reserve for the expenses you these things will handle.
The trade-off you face is that money in more conservative investments like bonds, CDs, or cash will likely generate lower long-term returns than money in more aggressive investments like stocks. As a result, there’s a balancing act you have to manage with this more conservative money.
You want enough a buffer so you can handle a typical bear market without having to sell your stocks to pay your bills. At the same time, you don’t want to invest so conservatively that you lose the ability to get the potential growth to cover your longer-term costs as inflation kicks in.
That’s what makes five years a decent goal. If you have enough savings to allow for a retirement of about 20 years, that means you can always keep a large enough reserve of stocks to help you in those later years. At the same time, if the market crashes early in your retirement, you have a buffer to give your portfolio a chance to recover before you need to sell your stocks.
Start putting your plan in place today
With a decent emergency fund and a reasonable spending buffer, you can give your stocks their best chance of working their magic in the long run, while still being able to handle the short-term pain of crashes. It’s a wonderful place to be if you expect the market to crash again at some point, but aren’t sure exactly when it will.
Recognize that it will take time to get your finances to the point where you can weather a typical stock market crash and come out stronger on the other side. So get started now and improve your chances of being ready the next time the market crashes.
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Chuck Saletta has no position in the stocks mentioned. The Motley Fool has no position in the stocks mentioned. The Motley Fool has a disclosure policy.
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