Why it is not a question of if, but when, and what we are going to do about it.
If something has gone up a lot, there is the possibility that it will come down again. The fear is, that it will be the “mother of all crashes” as some pundits have recently described an imminent fall in the markets of more than 50%. Without fail, there is always someone out there who is predicting the next doom and gloom disaster. Maybe it is because bad news sells, but certainly you can also get lucky. After all, the markets could just fall as part of a random universe, at which point one is hailed a genius.
The point is, when investing in equities, one must accept the reality that we could lose half at any time. We get compensated for taking this risk with an average annual return of more than 8% historically. That’s the trade, there is not much else to it, and all we have to decide is how much. I have met a lot of people who say they could tolerate large losses, but when it actually happens, it becomes a different story. If you can’t do the time, don’t do the crime, is a rather ominous saying, but the analogy is very clear. We can only invest so much as we can tolerate to lose.
Now that we have accepted our providence, we can look at what to do when the next big crash is upon us. On average, they come every ten years, yet by the time we realise what is happening, it is too late. In COVID terms, think of crashes as coming in waves. The first wave is sudden, brutal and there are no warning signs. Remember, every crash is different, otherwise there wouldn’t be a crash and as such there are also limits to protecting ourselves. All we can do is try to survive the first onslaught as best as possible.
Then we have a decision to make: do we buy more, or sell all we have? In the last forty years, there have been 37 market corrections with an average fall of 15.6%, and we would have done well to buy every one of them. On the other hand, when markets do fall further and more than 20%, we are in the second wave. Panic sets in, and most people will do nothing here, convinced that the world is going to end. By the time the third wave hits and takes us down by 50%, all hope is lost. Then, and only then, can markets rise again and we must buy all we can. In summary, predicting the next crash is a mug’s game, buying every correction is a no brainer, and keeping some powder dry for when things are seemingly at their worst, is how great fortunes are made.