A Stock Market Crash Could Be Life-Changing for Investors Who Have These 3 Things
Key Points
Investors should think long-term, including what to do if the market crashes.
One big preparation step is to make a shopping list.
Set aside capital now for when it might come in handy.
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A stock market crash can be frightening. Portfolio values plunge, economic forecasts worsen, and investors begin to question whether they should sell before things get worse. But for prepared investors, a crash can also create opportunities to build substantial wealth. Some of the world's best businesses can suddenly become available at prices that seemed impossible just months earlier.
The challenge is knowing what to buy and having the patience and financial resources to act.
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Three things can make a significant difference:
- The right time horizon.
- A shopping list of great businesses.
- Capital set aside to take advantage of opportunities.
Image source: Getty Images.
The right time horizon
The first requirement is a long investment horizon. If you need your money next year for a house deposit or other major expense, a market crash can be disastrous. You might be forced to sell investments at depressed prices.
But if you are investing money you won't need for the next 10 years, or longer, you have more flexibility to withstand temporary declines and allow businesses to compound their earnings.
Consider a company whose share price falls 40% during a market panic, even though its competitive position and long-term earnings prospects remain intact. An investor with a long time horizon can potentially benefit from the lower price. Someone who needs the money immediately may have no choice but to sell.
The key is to invest with money you can afford to leave untouched, rather than money you might need in the near future.
A shopping list of great businesses
Imagine your favorite supermarket announcing a 30% discount. You would probably know which products you want before walking through the doors.
Investing should work the same way. Rather than scrambling to find stocks during a market crash, prepare a list of businesses you would love to own at the right price.
For example, Alphabet (NASDAQ: GOOGL) (NASDAQ: GOOG) is an interesting company to watch. It owns Google Search, YouTube, and Google Cloud, while investing heavily in artificial intelligence (AI). These businesses give it several ways to benefit from the growing use of AI.
Another example is Amazon (NASDAQ: AMZN). Its e-commerce operations, cloud computing business, and advertising division provide multiple sources of growth. AWS also gives Amazon exposure to rising demand for AI computing.
Both companies have substantial businesses and long-term growth opportunities. But that doesn't mean their shares are attractive at every valuation.
This is where preparation matters. Study the companies, understand their competitive advantages, and identify the risks. Then estimate their value and determine the prices at which you would be comfortable buying.
The goal isn't to buy whatever falls the most. It's to buy great businesses when fear creates attractive valuations.
Capital set aside
Having the right time horizon and a shopping list won't help much if you don't have the money available when opportunities arise.
That is why investors should consider setting aside some capital specifically for market corrections. When markets fall sharply, investors with available cash have the flexibility to buy businesses they previously considered too expensive.
However, holding cash has a cost. Markets can continue rising for years, and nobody knows when the next crash will arrive.
One practical approach is to build an investment reserve and deploy it gradually. For example, you could invest part of your available capital when a company reaches your target buying price, then keep some aside in case its shares fall further.
Importantly, this money should be separate from emergency savings and funds needed for near-term expenses. You don't want to be forced to sell investments during a downturn because you need cash to pay your bills.
What does it mean for investors?
A market crash doesn't automatically create wealth. It creates opportunities, but only prepared investors are positioned to take advantage of them.
A long time horizon gives you patience. A shopping list gives you direction. Capital set aside gives you the ability to act. You need all three.
In other words, the next market crash could be one of your best investment opportunities. Make sure you're prepared before it arrives.
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Lawrence Nga has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet and Amazon. The Motley Fool has a disclosure policy.
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