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He FTSE 100 it has been on an impressive run in recent months, even hitting new all-time highs. However, despite this bullish momentum, not all investors are bullish. In fact, several analysts expect a stock market crash later this year.
Dr. Michael Bury, a former hedge fund manager who predicted the 2008 financial crisis, and GMO founder Jeremy Grantham have made bold predictions about an impending crash in 2023. And if his thesis is accurate, then stocks could plummet in the coming months.
Of course, this doomsday forecast is far from confirmed. And the bear group of investors may be wrong, as stocks will continue to rise as economic conditions improve. But let’s assume the worst case. What can investors do to protect their portfolios and capitalize on any impending volatility?
Preparing for a crash
A golden rule of thumb in investing is to never buy stocks with enough money within the next three to five years. Because? Because when periods of short-term volatility inevitably materialize, investors don’t want to be in a position where they’re forced to sell at terrible prices.
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, a high-quality company is likely to recover from the economic crisis before reaching new heights, taking the share price with it.
Selling stocks to mitigate losses is like trying to time the market, which is practically impossible. Too often, an investor will sell stocks only to see them rise a few weeks later.
Even if a stock continues to plummet, most investors delay buying back shares, creating substantial opportunity costs during the recovery period. It’s worth remembering that the best returns are generated during stock market rallies.
This is also the reason why it is crucial to have some capital saved. During a dip, panicked investors have a habit of selling anything with a pulse. And even the best companies in the world, unaffected by the catalysts behind the market downturn, can see their share prices plummet.
By making sure there is a ready supply of money, brave investors can capitalize on these deals, bolstering their existing positions or opening new ones at reduced prices.
Invest during volatility
Buying blue chip stocks during a stock market crash can generate substantial returns that beat the market over the long term. But this strategy is far from risk-free. During market turmoil, investment decisions are based primarily on emotional reactions rather than rational thinking.
Therefore, an investor who has identified a great deal that is trading very cheaply may still see the valuation fall further. That is why it is more sensible to inject excess capital into the markets, rather than investing it all at once.
That way, if prices continue to fall, the investor can further capitalize on the discounted valuation, lowering their average cost basis while raising their long-term return.
Of course, that is assuming the underlying business meets long-term performance expectations, which can never be guaranteed. Therefore, diversification also plays a critical role in managing risk during a stock market crash.
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