Apocalypse Tomorrow: Surviving a Downturn
Although we’re in the midst of one of the longest bull markets in history, the next downturn is always just around the corner. How can we prepare ourselves for when it finally hits?
We now find ourselves in the longest bull market in history, with the market rising more than 300% since bottoming out in the depth of the Financial Crisis almost ten years ago.
Though the going is good, 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.
Indeed, one of the constant questions that’s asked by members of the Invest community 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?”
Facing the Inevitable
First off, it is absolutely correct that a downturn is inevitable. Sure as night follows day, there will be a market downturn at some point in the future.
The rub is that we have no idea when it is going to happen, or long it will be, or how 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.
From Warren Buffett right down to an ordinary guy on the street, not one person 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. Even a stopped clock is right twice a day.
So, in full acknowledgment of our limitations as human beings, the best advice I can give you is simply not to worry about it. Really, you only have three options of mitigating against a downturn in the market:
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, not least that 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. If you’d listened to all the talking heads warning of a “double-dip recession” since 2009, for example, you’d have lost out on +300% 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: Autopilot
If you, like me, are investing for decades rather than months or years, you can take a 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 — it just 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: Cash Under the Mattress
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 bear market.
Essentially, you endeavour 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 recognises it as a necessary evil 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.”
