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At FTSE 100 has been on an impressive run for the past few months, even reaching a new record. But despite this upward momentum, not every investor is optimistic. In fact, some analysts are expecting a stock market crash later this year.
Dr. Michael Bury, a former hedge fund manager who predicted the Financial Crisis of 2008, and the founder of GMO, Jeremy Grantham, have made bold predictions about the crash in 2023. And if the thesis is accurate, then the stock can be set down in the coming months.
Of course, this doomsday prediction is far from confirmed. And a group of bearish investors may be wrong, with stocks set to continue climbing as economic conditions improve. But let’s assume the worst case scenario. What can investors do to protect their portfolios and maximize the inherent volatility?
Prepare for an accident
The golden rule in investing is never buy stocks with the money you need in the next three to five years. Why? Because while periods of short-term volatility are bound to happen, investors don’t want to be in a position where they are forced to sell at a high price.
As crazy as it sounds, often the best move during a stock market crash is to do nothing. Long-term investors have the luxury of time. And given enough time, high-quality businesses will be able to recover from economic turmoil before reaching new highs, taking stock prices down.
Selling stocks to cut losses is like trying to time the market, which is almost impossible. Too often, investors will sell stocks only to see them go up a few weeks later.
Even as stocks continue to decline, most investors delay in buying back stocks, incurring significant opportunity costs during the recovery period. It should be remembered that returns are best during stock market recovery.
This is also why it is important to save some capital. During a crash, panicked investors have a habit of selling anything on a pulse. And even the best businesses in the world, unaffected by the catalyst behind a bear market, can see their stock prices fall.
By making sure the wads of money are ready, brave investors can pursue these deals, strengthen existing positions, or open new ones at discounted prices.
Invest during volatility
Buying top stocks during a stock market crash can unlock huge market gains in the long run. But this strategy is far from risk-free. During market turmoil, investment decisions are primarily based on emotional reactions rather than rational thought.
Therefore, investors who have identified a good business trading at a low price may still see a decline in value. Therefore, injecting spare capital into the market, rather than investing it all at once, is wiser.
That way, if prices continue to fall, investors can factor in more discounted value, lowering their average cost basis while pushing up long-term returns.
Of course, if the underlying business meets long-term performance expectations, that cannot be guaranteed. Therefore, diversification also plays an important role in risk management during stock market crashes.
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