Stock market crashes, or even corrections, can be truly terrifying events. Most of us invest in ASX shares to build our wealth over time and to plan for a comfortable retirement. So to see years of your hard-earned capital lose 15%, 20%, 30% or even 50% of their value over what can be just a few weeks can be heartbreaking. It can also lead to panic selling, which is one of the worst ways to stab yourself in the back.
Unfortunately perhaps, stock market crashes are inevitable. We get one every few years, as consistent as the tides. Sometimes we might have 10 years without one, and sometimes there can be only three or four years between crashes. They are unpredictable but dependable in their occurrence.
So in order to be ready for the next crash (which could happen next week, next year or next decade for all I know), let's talk about five ways you can prepare for the inevitable.
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5 ways to prepare for the next ASX stock market crash
Understand what a market crash is
Understanding what exactly is a market crash is the first way you can help prepare for the next one. Market crashes are often caused by an underlying factor, such as a recession, credit crunch or (in 2020's case) a pandemic. But once one gets going, it's usually driven by investors' fear of losing money.
That's why you tend to see such savage drops in value. That's investors scrambling to pull their money out of the markets in fear of losing more. When you understand that a crash is driven primarily by this fear, it makes it easier to deal with on an emotional level. Not getting caught up in this panic is essential for surviving a crash with your wealth intact.
Have a plan
Leading on from our previous point, the second way you can prepare for a stock market crash is by having an action plan in place, ready for the next one to come around. If you spend time thinking about how you will handle a crash before it happens, there is a lower chance you will act in an emotionally driven way when it is happening and do something you will later bitterly regret.
So think about which companies you don't have too much confidence in your portfolio, or how much cash you'd like to have stashed away for some bargain buying.
Buy shares that you are confident can ride out the storm
It's important that you only buy shares that you are confident won't be terminally damaged by a recession or a market crash. If you own a company that is only just staying afloat during good times, how do you think it will fare when storm clouds fill the horizon?
The time to get out of a loser is when the sun is shining, not when everyone else realises that the company is headed for strife. This is tricky. No one knew that a pandemic was imminent in 2019, for example. But what is far more predictable is a recession. So make sure you fix any proverbial leaky roofs in your portfolio while the sun is shining.
Hold cash for the stock market crash
We already touched on this, but having a cash buffer is a great way to prepare for a recession. Many investors like to stay fully invested all of the time. It's a smart way to invest when markets go up more often than they go down. But some of the best investors like to build up a cash position too.
Cash doesn't lose its value during a crash like shares do. Plus, you can use this cash hoard to buy up shares of your favourite companies when everyone else is scrambling to sell them at a bargain basement price. That's how Warren Buffett has built most of his wealth, after all
Invest in defensive assets
I've left this one until last because I don't believe it is the best way to prepare for a crash, at least for ordinary investors. But some investors value certainty, capital protection and safety above all other factors when investing, so it's still worth discussing.
The final way one can prepare for a stock market crash is by investing in assets that typically hold their value or increase in value during tough economic times.
Those might include gold, government bonds, or infrastructure assets. These assets typically deliver lower returns than shares do over long periods of time. But they do usually hold up better than most shares during times of market stress or panic.
So for this reason, many investors like to allocate a certain percentage of their portfolios to these kinds of investments. If the idea of watching your portfolio lose 30%, 40% or even 50% of its value, even if it's temporary, spooks you to no end, then this might be a way of alleviating some of that fear. But you will probably risk some long-term returns if you do so.
