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Amid escalating geopolitical tensions overseas and historically high interest rates at home, the possibility of a stock market downturn is appearing more probable for some. Jeremy Grantham, a seasoned figure in the industry, is even cautioning investors about a potential disaster on the horizon.
Personally, I hold a different perspective regarding the stock market heading towards a significant catastrophe. While there are concerning factors to monitor, history has repeatedly demonstrated the stock market’s resilience, surpassing most people’s expectations. Nevertheless, I acknowledge the possibility that my viewpoint could be incorrect. This is why I’ve consistently found it prudent to hope for the best and prepare for the worst.
Keeping that in mind, let’s consider some approaches to confront potential future turbulence in the stock market next year.
Accumulate some cash reserves
Despite not yielding the most lucrative returns, maintaining a cash reserve can serve as an excellent strategy to withstand market challenges. Even in the face of escalating inflation, cash continues to outperform other asset classes in the short run. Perhaps most crucially, it provides flexibility.
Imagine a scenario where a market crash occurs, causing a 40% decline in an investor’s portfolio. Assuming that the portfolio comprises high-quality businesses, these investments will eventually rebound and reach new peaks. However, this process could take several years. One of the most undesirable positions an investor can find themselves in is being compelled to sell stocks at unfavourable prices to cover their expenses.
To evade such a predicament, establishing an emergency fund is essential. This cash cushion is designed to provide financial support to cover living expenses in the event of an interruption in regular income flow. If the recessionary forecasts of an economic collapse materialize, the need for this fund could be even more substantial, particularly with the likelihood of widespread job losses.
This cash reserve also acts as a source of capital once the situation stabilizes. Numerous stocks will be available at discounted prices, and investors with the means to seize these opportunities can potentially achieve substantial returns over the long haul.
Evaluate the business, not the stocks
Assessing a company’s value over a short period is challenging. It may be tempting to immediately offload shares to avoid further losses. However, in numerous cases, this is a common mistake made by inexperienced investors.
In the short term, stock prices are influenced by sentiment and momentum, with pessimism often prevailing during stock market downturns. Consequently, even if a stock experiences a 30%, 50%, or 70% drop, it could be far more prudent to consider purchasing rather than selling.
Volatility is the price every investor must pay, especially when seeking high-growth investments. Nonetheless, fluctuations in share prices can be a significant distraction from the ultimate priority – the business. A company may encounter short-term disruptions. Yet, if the long-term strategy remains intact, the volatility resulting from the crash may have created exceptional long-term investment opportunities.
In summary, the best approach to weathering a market downturn is to accumulate cash reserves and be enthusiastic about seizing opportunities created by apprehensive investors.
The article “How Should I Prepare for a Stock Market Crash in 2024” was published first on The Motley Fool UK.
The opinions expressed about the companies referenced in this article are those of the author and may differ from the official recommendations provided in our subscription services such as Share Advisor, Hidden Winners, and Pro. At The Motley Fool, we believe that considering a broad spectrum of perspectives can enhance our capabilities as investors.
Motley Fool UK 2023