As we approach the end of another calendar year, the financial media will soon turn its attention towards forecasts for 2018. And with global stock markets currently reaching new all-time highs I’ve already begun to see some market commentaries forecasting a stock market crash during 2018.
Although a crash, correction or downturn cannot be ruled out, the cause, accuracy of timing and depth of severity are well beyond anyone’s control or forecasting ability and a continued period of positive gains should not be universally dismissed. However, if you are genuinely concerned, here’s a 10 point checklist to help make sure that you are well prepared for whatever comes.
1. Accept That Crashes, Corrections and Downturns are Normal
Investments do go down and you need to accept that it is not an unusual occurrence. We’ve been lulled into a false sense of security during the last couple of years and you have to remind yourself that you cannot expect high positive returns year in year out without the occasional financial storm. Investing isn’t easy and coping with setbacks is part of the investment experience. Good investors try to keep things in perspective, which is easier said than done, but if a correction does eventually come, try not to see it as anything other than normal.
2. Filter Your News
Most financial news is entertainment. Try to remember that. Financial news is not written to help you or to be acted upon, it’s there to sell papers and gain clicks online. Market crash looming! Sell everything! Stocks ripe for a correction! Move to Cash Now! These headlines target your emotions because no one likes to lose money. But they’re written in isolation without any knowledge of your personal circumstances and with the medias track record of predicting most things wrong, why do you even read that stuff anyhow? Did it correctly predict the Tech Boom Bust, the Financial Crisis, the Brexit Referendum or Trump. If you’re serious about your finances then find two or three quality and objective sources of financial commentary and bin the rest.
3. Determine Whether You Should Be Investing in the First Place
Investing requires a time frame that is measured in multiple years and not in days, weeks or months. If you need all of your money back within the next 3 years then you shouldn’t be investing. Ideally your investment time frame is in excess of 10 years because it allows you to recover from the inevitable setbacks. If you have between 3 and 10 years you should be investing appropriately to the exit point, reducing your exposure to a risk of loss as you get closer to exit.
4. Make Sure You Have an Emergency Cash Fund
When stock markets crash, the last thing you want to do is to sell when the values are low. If you haven’t got a cash reserve it means that you potentially become a ‘forced seller’, someone who has to sell regardless of price just to meet their financial needs. An emergency cash fund provides you with go to money in a crisis. Everyone has a different comfort zone when it comes to cash reserves, but it’s not unusual to hold between 3 and 6 months net income in cash to meet unforeseen expenses.
5. Determine Your Investment Goal
Your investment goal isn’t to make an arbitrary annual return figure picked out of the sky. Your goal is to achieve a financial objective such as having enough capital to pay for your children’s future education or creating a retirement fund large enough to cover the expected costs of living in later life. Having an investment goal focuses your attention on what you need to achieve from your investments to meet your life ambitions. Say your portfolio lost 15% in one year, but you also knew that the average long-term return still allows you to meet your financial goal, wouldn’t that keep the short-term loss in perspective and keep you focused?
6. Decide How Much Risk You Need or Want to Take
Risk and return are joined at the hip. High risk comes with the potential for high returns but with regular periods of significant loss and vice versa. The amount of risk that you’re willing to take is personal to you but if you’re young and building up your assets you generally have more time to overcome setbacks. If you’re older and have already accumulated sufficient wealth then you may want to lower your risk of loss to avoid drawdowns that you may not have time to recover from. Reassess the risk that you are currently taking to make sure that it is consistent with your needs. Don’t take on a risk that you don’t need.
7. Set or Check Your Asset Allocation
You already know that you shouldn’t put all of your eggs in one basket and an asset allocation plan diversifies your investments into different ‘assets’ such as stocks, bonds and property so that if one should fail, the others can help stem your losses. I, like most financial professionals, firmly believe that asset allocation is the key to investment success. There are other contributing factors but the vast majority of the investment experience will be determined by asset allocation. Assets can be arranged to target an intended risk and return objective and if you currently invest without an asset allocation plan, then you could be exposing yourself to an unknown amount of risk. If you already have an asset allocation but haven’t reviewed it for some time then now is a good time to review.
8. Go Ahead and Invest
You cannot control the economic environment in which you find yourself investing and you’ll find numerous articles online dismissing completely the ability of people to time a market entry or exit. Don’t try to second guess where the market is going. No one has proven to be able to market time with any consistency and even the legendary investment manager Peter Lynch once said:
Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections than has been lost in corrections themselves.
Trust your plan, invest now or stay the course if you are already invested, because if you meet all of the earlier points then even if a market correction comes on day one after investing, you should have enough cash reserves and time to allow your plan to overcome the set back and still reach your goal.
9. Use Pound Cost Averaging
Investing monthly can help to remove the market timing issue entirely, but for those with a lump sum now, even deploying your investment over a period of time such as the next four quarters, rather than in one lump sum could help you come to terms with the problem. If markets correct, then at least you didn’t commit all of your money and if the markets continue to rise, then at least you got some working from the outset. This method is more about controlling the emotions of investing rather than the result itself as it allows you avoid the regret that can come from making a one-time decision that goes against you.
10. Repeat over time
Every time that a new threat to your plan presents itself, whether it be an impending market crash or a change in personal circumstances, go back to point one on the checklist and start over. Sometimes you won’t need to do anything, other times you may need to adjust and re-evaluate.
I’ve been helping our clients with these matters for over 20 years now and having worked through two of the largest crashes in market history and in addition to the numerous smaller corrections, I can honestly vouch for the success of the above checklist. Guessing what’s going to happen next or trying to predict the future rarely works well, whereas staying invested through thick and thin using an investment plan and asset allocation that matches your objectives and tolerance to withstand losses usually wins the race over time.
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