3 Smart Ways to Get Through a Market Crash
The stock market has been a rumbling, bumbling, stumbling mess over the past week and a half, and it's had plenty of traders on edge wondering whether or not they should cash in their chips and run for the hills.
Instead of running for cover, we decided to ask three of our top analysts for a strategy they would suggest investors employ to help them not only survive, but perhaps thrive in an environment where the market is falling. Here's what they had to say:
Todd Campbell: Figuring out an investing game plan when the market is nose-diving can make for some pretty poor decision-making, so it's best to think ahead. In my eyes dollar-cost averaging is the single best strategy for profiting from the market's inevitable pops-and-drops. That's because dollar-cost averaging frees investors from the single most risky investor behavior: investing emotionally.
Dollar-cost averaging is a simple investing technique that many investors are already doing thanks to 401(k) and 403(b) retirement accounts. Participants in those retirement accounts select an attractive investment, such as a low fee index mutual fund, and then contribute to it every pay period. Those contributions are made regardless of whether markets are climbing or falling and over time those investments can really build up. For example, let's say an investor begins putting away $200 per month in a 401(k) account when they are 25. Over the next 40 years (likely through a bunch of bull and bear markets) that account returns an average 6.5% per year (not unreasonable given long-term market returns). How much would the investor have set aside in that account for retirement? More than $450,000.
Using a similar dollar-cost averaging approach to your non-retirement investments can be similarly powerful. Most mutual fund companies and brokerage accounts allow for automatic contributions to accounts, so setting up a monthly auto-invest program simply means filling out a form (either online or via snail mail). Investors can either have their periodic investments go into a money market or a mutual fund investment. Of course, dollar-cost averaging works best for those with long time horizons because no one can tell you where the market will be in the short term. So, dollar-cost averaging won't guarantee that you make money, but it can free you from day-to-day monitoring of the markets, giving you more time to focus on career, kids, and vacation plans instead of media sound bites.
Jordan Wathen: One of my weaknesses is that I have an attraction to value stocks. Not Warren Buffett's current style of value stocks -- I mean the dirty, stodgy businesses in arcane corners of the market. The cheaper the multiple, the better.
Coming out of the financial crisis, I loaded my portfolio up with the cheapest of small-cap stocks. Two traded for less than their cash on hand. Most traded for less than five times earnings. When I say cheap, I mean really cheap.
In retrospect, this strategy has a fatal flaw. Virtually all of my holdings were later bought out by competitors, and I had to go back digging again just to replace what owned. Sure, the returns were excellent, but my portfolio had far too many empty spots for far too long.
Cheap stocks may always be my mainstay, but next downturn, I'll definitely dedicate a portion to quality, too. I've built up a short list of companies I really admire -- companies that could grow at above-average rates for decades. Stocks like Capital One Financial, Visa, and Markel come to mind. And if they go on sale, I'm going to get real interested.
And though the Ben Graham disciple in me may cringe at paying full price for top-shelf companies, he'll have to take a backseat if the stock markets take a significant decline. The next crash will bring the start of my buy-and-ignore portfolio that can serve as an alternative to the cheap, "cigar butt" stocks I love so much.
: The stock market is in free fall and you're curious what to do? That's simple. Just stick to your investment strategy by purchasing high-quality dividend stocks.
Why dividend stocks? Dividends serve a dual purpose for investors. Not only do dividends add money to our pocketbooks and help hedge our losses when the stock market is heading south, but dividends themselves are a way for a company to demonstrate that it's financially sound. In other words, a company that's increasing its dividend with some regularity is telling investors "Hey, look at me! My business model is healthy regardless of the economic environment."
Best of all, dividend stocks allow you to really double-down on your time advantage by reinvesting your dividends. As a fun example, imagine you invested $10,000 into a dividend stock that has a 3% yield, a 3% annual dividend growth rate, and whose stock price gains an average of 8% per year (the average gain for the market, historically speaking). Also imagine that you made this investment at age 25 and cashed out at 65. If you pocketed the dividends your investment would be worth $240,544. If, however, the dividends were reinvested, you would have nearly $366,000!
The point here is simple, find great quality dividend stocks with business models that will stand the test of time and you'll be just fine. These are companies like Johnson & Johnson which has a 52-year streak of boosting their dividend and is relatively immune to economic downturns thanks to its high-margin pharmaceutical business and consumer goods division, or Coca-Cola which is geographically diverse and delivers an inelastic product that also stands the test of time. This is the smart way you weather any sharp downturn in the stock market.
Is this your best bet to beat a crashing market?
The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That's beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here.
The article 3 Smart Ways to Get Through a Market Crash originally appeared on Fool.com.Todd Campbell, Jordan Wathen, and Sean Williams have no material interest in any companies mentioned. The Motley Fool recommends Coca-Cola, Johnson & Johnson, Markel, and Visa. The Motley Fool owns shares of Capital One Financial., Johnson & Johnson, Markel, and Visa and has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Copyright © 1995 - 2014 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.