Although we’re in the midst of one of the best markets we’ve ever seen, we’re always cautious of when the next downturn will hit. So what are our options to prepare ourselves for when the down-market finally rolls around?
This week marks the 8 year anniversary of the current bull market that we find ourselves in – the second longest positive run in history. At present, it’s 78% longer than the historical average.
Situations like these lend themselves to a lot of speculation as to when the next downturn will occur. Many say it’s just around the corner, while others claim that we still have a few years left to prosper.
But one of the constant questions that’s asked by our users goes something along these lines:
“With the inevitable downturn about to happen, why should I invest now rather than wait until I can buy all these stocks for cheaper?”
The Inevitable Downturn
First off, it is absolutely right that a downturn is inevitable. Sure as night follows day, there will be a market downturn at some point in the future.
We have no idea when it is going to happen, and we have no idea how long or severe it will be. The only thing we know is that one will eventually happen.
And when I say “we have no idea”, I’m talking about everyone. No one can accurately predict the rise and fall of markets. Of course, people try week-in week-out to call the top of the market, and someday one of them will get it right – but no one can consistently do it.
With that in mind, the best advice I can give you is simply not to worry about it. Really when it comes to investing in the markets, you have three options:
Option One: The Waiting Game
You could, if you wish, just keep all your money in cash and wait for the next downturn. But there are a few problems with that.
Firstly, you’ll miss out on any of the positive returns that occur while you’re waiting. That may not seem like a big risk in order to protect your capital, but that all depends on how long you’re willing to wait.
A year ago, analysts at RBS made the headlines when they told their investors to brace for a “fairly cataclysmic year” and to “sell everything”. The market is up about 22% since then.
If you’d listened to all the talking heads warning of a “double-dip recession” since 2009, you’d have lost out on about 243% of gains.
So keep in mind that stuffing your cash under your mattress brings with its own risks – the risk of losing out.
Option Two: Time in the Market -vs- Timing the Market
If – like me – you are investing for decades rather than months or years, you can take this far more philosophical approach.
We know from history that despite the bumps along the way, the stock market trends consistently upwards over long periods of time. In fact, if you had invested on the first of January of any year in history and held for twenty years, you’d never once have lost money. That’s why we try to teach long-term buy-and-hold investing – because it works.
If you were to take this option, you would ignore what’s happening in the overall market, and invest whatever you can afford whenever you’re able. It’s like putting your portfolio on autopilot. When the market is going up, your portfolio is going up, so all is good. When the market is going down, you’re benefitting by buying great companies for cheaper than before.
The big risk here is that you invest just before a major downturn and it may take a few years to recover. But again, if you’re investing for the long haul, you can be more philosophical about this and know that at some point, you’ll likely make your money back and eventually profit.
Option Three: Keep Some Cash Handy
This is a great option to take in order to benefit from the upside of a bull market while at the same time covering yourself in the case of a market downturn.
Essentially, you endeavor to always keep a percentage of your money in cash. How much you keep in cash is totally up to you and will likely depend on your attitude to risk. For example, if you were quite bullish on the market, you might keep 5-10% in cash. If you feel a downturn is imminent, you might stretch that to 30%.
Then when the downturn eventually does happen, you can use that cash to buy up cheap stocks.
This is a strategy that gets the backing of Warren Buffett, who hates holding cash but recognizes it at a necessary tool for acquiring cheap stocks. As the Oracle said to Berkshire Shareholders;
“The one thing I will tell you is the worst investment you can have is cash. Everybody is talking about cash being king and all that sort of thing. Cash is going to become worth less over time. But good businesses are going to become worth more over time. And you don’t want to pay too much for them so you have to have some discipline about what you pay. But the thing to do is find a good business and stick with it. We always keep enough cash around so I feel very comfortable and don’t worry about sleeping at night. But it’s not because I like cash as an investment. Cash is a bad investment over time. But you always want to have enough so that nobody else can determine your future essentially.”
I have to agree with that. Cash is really is a terrible investment. But as much as we’re in the business of picking great companies to invest in, we also love to pick up bargains when we see one. Having a part of your portfolio in cash is a good method for making sure you’re prepared for a rainy day.
To leave you with another Buffett quote, “When it starts raining gold, reach for a bucket”.