What To Do When The Stock Market Crashes

By | 2018-12-28T20:44:42+00:00 28 December, 2018|Investments|

The bull market is approaching its 10-year anniversary, and there are signs that a recession may be in the cards in 2019.

If you remember, the stock market reached its low in March 2009 at the height of the financial crisis which was precipitated by a devastating sub-prime mortgage lending crisis. Borrowers could easily borrow loads of money without much documentation which in turn fueled a speculative housing bubble. The housing bubble burst in 2007 leading to the Great Recession immediately thereafter. Since then, however, the stock market has recovered profoundly, and reached multiple new all-time highs throughout 2017 and 2018.

That said, though, the stock market is not a one-way street. The next recession will hit investors sooner rather than later and it will lead to lower corporate earnings and decreasing stock prices. As investors fear even lower stock prices in the context of a contracting economy, they sell their positions into the weakness, driving stock prices even lower. A self-fulfilling prophecy.

The question, though, is: What should long-term minded investors do when the stock market hits the brakes and stock prices begin to decline?

The short answer is: Don’t panic. Keep your cool and focus on your investing game plan.

The game plan should, ideally, be a long-term financial plan that lays out your financial goals, objectives, your risk tolerance and your unique personal/financial circumstances.

Instead of panicking at the sight of declining stock prices, playing the long game is the best thing you can do for yourself. Don’t worry about short-term price swings in the stock market on any given day or week. Rather than chasing stock prices or hiding in panic, focus entirely on building a long-term oriented, diversified investment portfolio that consists of high-quality dividend-paying stocks with a history of earnings and dividend growth.

Companies that have raised their dividend payouts during the last economic downturn are more likely than others to keep growing their dividends in the future which makes them excellent income stocks to hold for the long haul.

I have been through two major stock market crashes in my life, the dot-com bubble in the late 90s and the U.S. sub-prime meltdown in 2007-2008. I have learned heaps of stuff during those two major meltdowns.

Here are a couple of rules that investors may want to follow in case the stock market tanks in 2019:

 

1. Keep Your Cool.

Don’t panic, don’t be emotional. Stock prices correct from time to time. This is a temporary thing. Falling stock prices are not the end of the world.

 

2. Focus On Building A High-Quality, Durable Income Portfolio.

If you have built a high-quality, diversified investment portfolio with strong companies, you have nothing to worry about, even in the event of a recession.

Companies that have a history of dividend growth throughout past economic cycles have a higher-than-average chance of continuing to grow their dividend payouts. Though the market prices of your stocks might change and produce paper losses from one day to the other, you don’t have to sell!

In fact, chances are that if you built a high-quality portfolio consisting of dividend-paying stocks, your dividend income most likely won’t change much at all during the recession (it might even rise if the companies in your portfolio continue to grow their dividend payouts). Don’t let the rapidly changing market prices irritate you: As long as you produce stable dividend income from your investment portfolio, you will be fine.

 

3. Always Reinvest Your Dividends!

I can’t stress this enough. You MUST reinvest your dividend income, bond income, real estate income into new income-producing assets in order to fully take advantage of the power of compounding. Check this article out that explains why compounding makes such a huge impact on your nest egg.

 

4. Dollar-Cost Averaging

In my opinion, one of the best things long-term minded income investors can do is to buy stocks during a recession when they are out of favor. When investors don’t want to touch stocks with a ten-foot pole, they are usually at their cheapest and have compelling total return potential for investors that play the long game. Load up on quality dividend-paying stocks during a recession!

Adding to your position when stock prices are falling is called dollar-cost averaging.

Dollar-cost averaging means your average cost of an investment position decreases if you buy more stocks at a lower price. Say you bought 10 stocks of company A @$100 a piece for a total of $1,000. Assume the stock drops to $90. If you buy 10 stocks again @$90, you pay another $900 to double your position. But because you bought at a lower price the second time, the average price you paid for company A’s stock has decreased from $100 to $95 (10x$100+10x$90/$1,900).

Dollar-cost averaging allows you to lower your cost basis. I utilize this strategy quite a lot when stock prices fall, and I am very happy with the results so far.

 

Takeaway

The big takeaway here is that you don’t have to worry about falling stock prices as long as you play the long game. Focusing on the long-term, say 10 years or more, is an excellent way to deal with market volatility and condition yourself to keep your cool when other investors are panicking.

If the market drops again in 2019, instead of panicking, appreciate the fact that you can now buy more stocks at discounted prices. Buy quality stocks, collect and reinvest dividends, retire early!

If you have any questions about investing or want to know more about my investment portfolio, drop me a message here and send me an eMail at chris@retiredby35.com.