“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” – Peter Lynch
It is not a matter of if but when US stocks experience a full-fledged bear market. Of course, as famed investor Peter Lynch noted, many investors spend years predicting/anticipating stock market corrections, and in doing so take actions that cause far more in losses (real and/or opportunity costs) than occur during the correction itself. That said, there are prudent things you can do to make sure you are prepared for the next major market decline, whenever that should occur.
Make sure your assets are aligned with your investment time horizon. This is the very most important rule in investing. For funds you need in the near term – for monthly expenses, some type of financial event in the next year or two, etc. - have these in cash or short-term instruments. For capital you need to be working for you for 3, 4, 5 years or more (people often vastly underestimate their true investment time horizon, thinking their retirement date represents the end of their investment journey whereas in reality you will likely need your money to work for you for another 10–30 years thereafter), this should be deployed in high-quality, dividend paying stocks and other longer-term securities. For the in between funds, there are myriad asset classes that can provide above cash returns but not be subject to potential big swings that occur from time to time for stocks (AKA volatility).
Sharpen your pencil and revisit #1. Ibid.
Employ a hedging strategy for some of your medium term capital (i.e. stocks you own not for the very long term but for that 2–5 year time horizon). If you don’t know how to do this, find a professional with 10+ years of experience hedging so that they have been through several major market moves.
Study how long bear markets tend to last. The Dalai Lama notes that all human beings suffer. Much of it is self-inflicted (lamenting the past, worrying about the future), some of it comes from the outside. For negative events which are inevitable but the timing unknown (e.g. sickness, death, bear markets), the Dalai Lama recommends to think about them ahead of time – to be prepared emotionally and spiritually - rather than to ignore them or pretend these events will never occur. By looking at bear markets objectively in terms of how long a typical one lasts (under a year – the 2008/2009 bear market being a big exception to the rule, it just happens to be the most recent data point therefore in everyone’s near-term memory), and acknowledging that it is inevitable, you are far less likely to take action when it occurs that is against your personal financial interest. I realize this sounds like approaching investing in a ‘soft’ way, but in reality the biggest impediment to most investors success is their own mind - and inability to control their emotions. That is why Buffett is quoted as saying his greatest strength as an investor is his emotional temperament (namely stability).
Take profits on (or hedge) some of your high flyers (high P/E ratios stocks) and shift this capital into more value oriented dividend paying stocks. Historical data shows that low P/E dividend stocks tend to go down less than their high P/E brethren during market corrections. Plus, the dividend gives you a profit source during price declines, as well as a way to dollar cost average to a lower effective purchase price.
Work with a seasoned investment professional who can help you make sure you are well diversified and in the appropriate asset classes – and be an objective, reasoned voice with a steady hand on the tiller when the storm hits.
Think back on your behaviors in 2016 when the market declined close to or more than 10% several times (Jan/Feb, BREXIT, etc.) and recognize that taking no action is often the best course of action even if your emotions are screaming, “Do Something!!!”
Save more/spend less. Often you can improve your financial picture far more by making a few smart choices over things for which you have total control – eating at home rather than going out to eat, etc. – which (when done repeatedly) will have a bigger impact on your financial picture than a near-term stock market drop (assuming you don’t panic and sell long-term money at a low). Better yet, take those savings, let them build in cash for now, and when you feel compelled to do something during the next market crash, buy yourself some high quality dividend paying stocks on sale. When they go back up in a few weeks or months or even a year or two, treat yourself to a nice dinner out or vacation or whatever else gives you pleasure.
Summer is just around the corner. It is a great time to enjoy the outdoors, family, perhaps some new activities. Take steps now to prepare for a possible bear market (note: this is not a prediction – the best time to prepare for the future is always today). If stocks decline during the long days of summer, you can continue to focus on important, high quality life matters, not hour-to-hour stock price fluctuations.