How can you prepare for a stock market crash?

Stock market crashes are inevitable so you'd better be prepared.

a woman

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Stock market crashes are simply a fact of life. They don't happen often but they always happen eventually and when they do they can decimate your portfolio. Fortunately, there are a few steps you can take to limit losses and ensure that your investments bounce back quickly.

  1. Do not sell. During a crash you will experience huge emotional pain and the temptation to sell will be high. The problem is accentuated by the ongoing bombardment of opinion and information we receive in today's internet age. It may be best to avoid looking at your portfolio altogether to counter the urge to sell at these times.
  2. Keep a decent chunk of cash at all times. How much is a personal judgement, but I would say at least 10% is sensible. Having cash to deploy when sentiment is dire and prices are crushed is the only way to create opportunity out of this horrible experience. Maintaining a shortlist of businesses that you would like to own at lower prices will help you make the right purchases when the time comes.
  3. Only hold high conviction stocks. These are cheap stocks of high quality businesses. What these are will vary from person to person. Although "one man's trash is another man's treasure" the crucial thing is that you personally have high confidence in each of your investments. If you don't, then it will be impossible to resist the urge to sell during a crash. A simple test of conviction is being able to crystalise the value proposition in a few sentences.

Always remember that a stock price is simply the last price someone was willing to pay for a business. This rarely coincides with the true worth of that business, which is equal to the total future cash flows discounted for the time value of money.

The beauty of owning high-quality businesses is that future cash flows keep rising and so it is hard to pay more than they are worth. However, almost any stock is a buy at a sufficiently low price and every stock is a sell at a sufficiently high one.

Regardless of which stocks you buy, you should only hold them if you strongly believe they are worth more than the current share price. If you follow this rule, then why would you think about selling when prices crash?

Motley Fool contributor Matt Brazier has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

More on ⏸️ Investing

A white and black robot in the form of a human being stands in front of a green graphic holding a laptop and discussing robotics and automation ASX shares
Technology Shares

Joining the revolution: How I'd invest in ASX AI shares right now

Advances in artificial intelligence (AI) could usher in a new industrial revolution. Here’s how you can invest in it.

Read more »

Close up of baby looking puzzled
Retail Shares

What has happened to the Baby Bunting (ASX:BBN) share price this year?

It's been a volatile year so far for the Aussie nursery retailer. We take a closer look

Read more »

woman holds sign saying 'we need change' at climate change protest
ETFs

3 ASX ETFs that invest in companies fighting climate change

If you want to shift some of your investments into more ethical companies, exchange-traded funds can offer a good option

Read more »

a jewellery store attendant stands at a cabinet displaying opulent necklaces and earrings featuring diamonds and precious stones.
⏸️ Investing

The Michael Hill (ASX: MHJ) share price poised for growth

Investors will be keeping an eye on the Michael Hill International Limited (ASX: MHJ) share price today. The keen interest…

Read more »

ASX shares buy unstoppable asx share price represented by man in superman cape pointing skyward
⏸️ Investing

The Atomos (ASX:AMS) share price is up 15% in a week

The Atomos (ASX: AMS) share price has surged 15% this week. Let's look at what's ahead as the company build…

Read more »

Two people in suits arm wrestle on a black and white chess board.
Retail Shares

How does the Temple & Webster (ASX:TPW) share price stack up against Nick Scali (ASX:NCK)?

How does the Temple & Webster (ASX: TPW) share price stack up against rival furniture retailer Nick Scali Limited (ASX:…

Read more »

A medical researcher works on a bichip, indicating share price movement in ASX tech companies
Healthcare Shares

The Aroa (ASX:ARX) share price has surged 60% since its IPO

The Aroa (ASX:ARX) share price has surged 60% since the Polynovo (ASX: PNV) competitor listed on the ASX in July.…

Read more »

asx investor daydreaming about US shares
⏸️ How to Invest

How to buy US shares from Australia right now

If you have been wondering how to buy US shares from Australia to gain exposure from the highly topical market,…

Read more »