Investing Rule No. 1: Don't Believe Doomsayers
There's no such thing as a stock market psychic, but there are ways to protect yourself from the next disaster (and from your own misguided tendencies).
Here’s when the next stock market crash will happen …
Tell the truth — when you saw this declaration, did you continue reading because you suddenly wanted to drastically rearrange your portfolio or take all of your money out of the stock market? If so, you can relax a minute. This post isn't designed to make you sound the alarm and get out before another crash happens. And we're not going to suggest that you go all in before the next boom happens either.
In fact, this post isn't intended to do anything of the sort. Instead, it’s to help you understand three important tenets of successful investing:
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- Sound investors always ignore the doomsayers.
- You can (and should) protect your investments from the market volatility without taking extreme measures.
- Excessive loss aversion can force you into poor financial decisions.
Why Psychics Make Bad Investors
There's good news and bad news if you're feeling desperate to know when the next stock market crash or correction will happen. The bad news is that we have no idea when it’s coming. And no one else really knows either, no matter how far they go trying to convince you they've figured out some deep, dark market secret.
We'll get to the good news in a moment. In the meantime, here are four great reasons to ignore the stock market doomsayers.
- These stock market prophets of doom are always trying to sell you something. Always.
- Over any protracted length of time, the markets are much more stable than the doomsayers want to admit.
- The doomsayers are always wrong, at least over the long term.
- If you accept the counsel of a doomsayer, you’ll be making a decision based on emotion, which is always a bad idea.
The Good News About Market Uncertainty
Now for the good news and the most important knowledge to take from this article. You can prepare your investments for the next stock market crash or correction, even if you don't know when it's actually going to happen. You don't need certainty to be a successful investor. The key is steering your portfolio effectively as the market moves between its boom-and-bust cycles.
Here's what you can do to protect yourself from the next market disaster.
- Always make sure your portfolio is highly diversified across asset classes, industries and countries.
- Examine your portfolio to assess if you have the appropriate amount of equity exposure for your personal goals and for your risk tolerance level. You can gauge this by asking yourself what would happen if your portfolio's value were cut in half. If such a loss would greatly threaten your investment goals or force you to sell, then you most likely should not have 100% of your portfolio in the equity markets. That’s because a drawdown of 50% is very possible for a portfolio fully invested in equities.
Loss Aversion and Poor Financial Decisions
One of the most important things you need to understand about anticipating a market crash is the profound effect that intense feelings of loss aversion can have on your decision making. Loss aversion can be described as follows:
The idea of losing a (supposedly) valuable asset is sometimes so unpleasant that it can lead to poor economic decision making. Loss aversion can make you irrationally committed to the status quo, sometimes to the point where inaction or stubbornness can lead to the very financial devastation the behavior was intended to avoid.
In other words, loss aversion can turn the possibility of financial damage into a self-fulfilling prophecy. You can avoid this dismal fate only by remaining vigilantly self-aware at all times and making wise, calculated financial decisions, not ones based on emotion.
So, at the end of the day, the question isn’t whether or not you know when the next market crash or correction will occur. It’s whether or not you’re adequately prepared when it does.
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