Investing is a volatile process and there can be a stock market crash at any time. People often lose money investing because they try to time the market, or see the market as a way to get rich quick. There is also an emotional element to investing which can often influence and confound investors. This is why I have written out my 10 golden rules for survival in the stock market.
The principles in this article are designed to help during turbulent economic times such as this week’s stock market response to the Corona Virus pandemic fears. Where $3.4 trillion was wiped off the stock market in a week.
1. Investing As A Time Capsule
One of the great psychological comforts is knowing that I can withstand the volatility of the stock market. In fact, when I invest money into my stocks and shares ISA, it’s as though I’m putting it into a time capsule. This money is locked away, passing through time, unaffected by years, even decades of market crashes and corrections.
Research on bear markets and market correctionsindicate that the market will drop by 5% or more, 3 times per year on average, 10% or more once a year, 15% or more once every 3.5 years and 20% or more every 3.6 years.However, the fact I won’t be spending this money gives me confidence in my investing strategy. I know it will have more than enough time for it to recover before I start withdrawing it.
2. Invest For The Long-Term
The golden rule for investing is to invest for the long-term, whether this is in an individual stock or an index fund. As Warren Buffet puts it “If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes.”I believe this applies to not only individual stocks but the whole market.
You have to be prepared to let the market rise over time and the eventual reward of years of compounding. Also, you need to be prepared for the fact you could invest and the next month there is a bear market. In the US, these are on average 1.3 yearsbut historically these have lasted up to 2.8 years.
3. Track Net Worth
With the above in mind, tracking my net worth is a good idea for two reasons. One as a motivator for investing over the long-term, seeing my wealth grow over time will be rewarding in itself. I can also set myself goals to hit in order to achieve financial independence.
I can celebrate these milestones (e.g. £100k) when I pass them. As Denzel Washington put it in a graduation ceremony speech “dreams without goals are just dreams… and they ultimately fuel disappointment.“ (03:06)
The second is grounding myself in perspective with market rises and dips. Tracking net worth will give me hard evidence of the progress I’m making, even if the market is down one year. This will prevent me from being driven by any subjective perceptions or emotions during down markets.
4. Invest With Index Funds
I will always invest the majority of my wealth in index funds. This is a strategic and logical approach to investing. I don’t want to get distracted or stressed by trying to take shortcuts. By this, I mean trying to find quick wins by buying and selling companies over a short period of time.
I need to have confidence in the maths behind investing in index funds. I might dabble in individual stocks as a hobby but my plan to become financially independent is grounded in the index fund strategy. Read more about why I prefer index funds by clicking here.
5. Reduce Exposure To Stock Market News
Research shows that we are more sensitive to a loss than a win. There is also evidence that the more you check stock news etc the higher chance there is of seeing that your portfolio is down. In fact according to Nick Maggiulliat Of Dollars & Data even for a simple 60/40 portfolio, this is how often you’re likely to see a loss in your portfolio:
- 46% of all daily returns
- 36% of all monthly returns
- 33% of all quarterly returns
- 26% of all yearly returns
Limiting exposure to these red flags is a good way to win the psychological battle of investing. It’s also important to remember that often, the business you are invested in, still exist and are making money. It’s just the valuation of them has changed. For example, would you sell your house just because someone suddenly came along and offered you much less than it was worth?
6. Keeping Investment Expenses Low
There are a number of funds out there that charge high fees. These can account for quite a significant amount, even when at small values.
During the good markets, this might even seem justifiable. However, when the markets are performing poorly, you not might not just be losing say 5% a year, you can round this up to 6-7%.
Let’s look at some very simple figures on how the annual fee amount you would be paying at various balances and percentage fees. As you can see, small percentage increases make a massive difference annually. Add a 0 and move a decimal place and you can see the impact over 10 years.
Table 1: Annual Fees
| Annual Fees by % Charge | |||||
| Fund Value | 0.25% | 0.50% | 0.75% | 1.00% | 1.25% |
| £50,000 | £125 | £250 | £375 | £500 | £625 |
| £100,000 | £250 | £500 | £750 | £1,000 | £1,250 |
| £150,000 | £375 | £750 | £1,125 | £1,500 | £1,875 |
| £200,000 | £500 | £1,000 | £1,500 | £2,000 | £2,500 |
| £250,000 | £625 | £1,250 | £1,875 | £2,500 | £3,125 |
| £300,000 | £750 | £1,500 | £2,250 | £3,000 | £3,750 |
| £350,000 | £875 | £1,750 | £2,625 | £3,500 | £4,375 |
| £400,000 | £1,000 | £2,000 | £3,000 | £4,000 | £5,000 |
| £450,000 | £1,125 | £2,250 | £3,375 | £4,500 | £5,625 |
| £500,000 | £1,250 | £2,500 | £3,750 | £5,000 | £6,250 |
7. Hold A Diversified Of Stock Portfolio
Diversifying by geography gives me that added confidence that I’m not just betting on one horse. Despite it being a global market, the evidence shows that some economies can underperform compared to others. For example, think of Japan’s ‘Lost Decade‘, a period of economic stagnation in the 1990s. This is one of the longest periods of economic crises in history.
Another recent example is the eurozone in the 2000s. Italy, in particular, is barely bigger than it was back in 2000. By contrast, the US indexes such as the S&P 500 have surged over this same period, just passing a 10 year anniversary in February 2019.
In fact, some speculate it could last another 10 years, only time will tell. However, the point is, in the next 10 years the US economy could stagnate and Italy could go on a bull run over the same period. Therefore, it’s important to diversity across the global market.
8. Maintain A High Equities Ratio
As I’ve mentioned in my financial planI currently hold an asset allocation of 95%+ in stocks. This is for the reasons I also mentioned in my post ‘where to start in the scary world of investing‘. The main reason, however, is that 100% equities allocation is the most optimal asset allocation over the long run. It outperforms any kind of asset mix between stocks, bonds, and cash.
Even when approaching retirement I will keep 75%+ in stocks. As researchhas demonstrated, an asset allocation of 75% stocks / 25% bonds has a 100% success rate over 30 years when withdrawn at 4%. This drops to just 98% when the allocation is 100% stocks. One thing that might sway my decision is if I was going to withdraw at a higher rate, say 5-6%. Probability dictates I should lean towards a high bond allocation in this instance.
9. Investing Opportunity During A Stock Market Crash
Past history shows that the 12 month period after a bear market can be a very strong period of growth, by as much as 124%. Investors who would have fled to cash or gold in these periods would likely miss this resurgence. It also seems wise to invest to a greater extent prior to this resurgence. This means investing or staying invested during the bear market is key.
Bear markets can also be a great opportunity to invest due to depressed stock prices. For example, at the height of the tech bubble in the 1990s, the P/E ratio for the S&P 500 was close to 40. At the bottom of some bear markets, the P/E ratio has been closer to 7.
This is the stock market equivalent of a sale. In a retail environment, would you decline to buy something you wanted because it had been discounted by 80%? Therefore for some investors, a stock market crash is not a dreaded thing but an opportunity.
10. Always Have An Emergency Fund
Having a cash buffer is likely to reduce the chance of my panicking or having to sell during a stock market crash. Especially if I was to not have a job during this period, this would be the worse case scenario. I would essentially be pound cost averaging in the wrong direction.
In fact, people in these positions are affected by loss aversion to a greater extent and thus more likely to panic sell.On the upside having surplus cash would allow me to achieve number 9, ‘investing in the dips’. Having an emergency fund will also have the psychological benefit of not needing the money I have invested.
Final Thoughts On Investing During A Stock Market Crash
I have come to understand that the stock market is volatile, it has its dramatic ups and downs. However, if you approach investing in the stock market from a long-term perspective, this makes all the difference. Having an investment plan can also smooth out this volatility.
Essentially approaching the market in a logical rather than an emotional way is fundamental to survival in the stock market. Being able to withstand stock market corrections and crashes is crucial to not losing money in the stock market. As selling-off your stock during a time such as this can be the worst thing an investor can do.
As Benjamin Graham once said: “The investor’s chief problem– even his worst enemy– is likely to be himself.
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