Last year in November, I wrote about the harsh reality of the stock market. The market conditions were so irrational that all the clues pointed to a crash. It turns out 2022 is the year of the crash, and it could very well be just the beginning.
A big recession is looming, big companies are freezing hiring all around the globe, inflation doesn't seem to be contained, and the war in Ukraine is still not over yet.
This week, Elon Musk mentioned that Tesla will freeze hiring and potentially cut 10% of staff for fears of a recession.
Elon Musk now tells execs Tesla needs to 'pause all hiring worldwide' because he has a 'super bad feeling' about the economy https://t.co/rGcILKCMAy
— Daily Mail Online (@MailOnline) June 3, 2022
All those news sounds terrible, but let me tell you a secret. When there's panic, there's also opportunity. This may actually be the opportunity of a generation to invest in great companies at amazing prices.
Preparation is everything
We, as investors, live with the risk of the stock market crashing every day. As it happened before, it will likely happen again. The key is to be prepared and not make any hasty decisions.
Timing the market is very difficult. Even if you know a crash will happen in a month or two, what will you actually do about it? If you go 100% in cash, you will actually lose 10% a year due to inflation, or you can stay and risk losing 50% more while the market crashes and you get caught.
Another question you may have is. Why not sell now and get back in later? While this is an excellent point, I'd ask you how you would know when to get back in? If you time it wrong, you could risk losing your money anyway.
I am not a financial advisor, and I can't tell you how to manage or prepare your portfolios in current circumstances, but what I can do is share what I learned while investing every month during the good and bad days of the market.
Back in November when I wrote the article about the market crashing I sold some of my positions to prepare for a crash. I was happy I was right and protected my portfolio from a much more significant loss. I was now sitting with cash aside, patiently waiting for the crash to end, so I thought. In March this year, I entered back in the market when a bottom seemed to be forming. The prices were too good to ignore. I thought it was the perfect place to enter, and to my surprise, the market shot up the following days for a 16% relief rally. That rally is now over, and the market crashed back down another 25%, 12% more since I bought back in.
We can't time the market. As logical as it may seem, we can't. We also react to emotion in some way or another. I am impatient, so I jumped back in too soon. Some people manage to time it perfectly, but everyone out there has a bit of luck on their side.
My portfolio is currently down a fair amount, though my discipline is paying off. My strategy was to divide my portfolio and have half dividend blue-chip stocks and half growth stocks.
Last year when growth stocks were massively overhyped, I bought only dividend stocks at a point where my dividend portfolio was higher than my growth one. I didn't feel like I was doing the right thing at the time, as I didn't see any profit compared to the massive rallies we had on tech stocks. After the 30% crash in the Nasdaq index this year, the only portfolio in the green 15% is my dividend portfolio I was building during the massive tech bull run last year.
Preparation means everything. We can't time the market, but we can decide not to invest when people are greedy and stay away from the hype stocks when we see them. Always look for opportunities and don't get distracted by the massive short-term gains. You never know how long they'll last. Have a plan and stick with it. You'll be as surprised as I am now to see the boring strategies are paying off when it matters the most.
So, how to protect your portfolio during a recession? Here are some of my personal strategies and rules I follow every time I make an investment during a market crash. I have to say, however, that you should seek professional financial advice before making any important decisions for your portfolio.
Rule #1. Invest in good companies
Focus on fundamentals and invest in quality companies. You may hear this every time. During a recession, only good companies survive. When interest rates rise, you want to focus on companies with a clean balance sheet with low debt and high cash positions.
You want to look for businesses that generate consistent revenue with great cash flow and strong margins. Those companies can survive any crash out there without any significant damage.
The first to fall are the companies that need to raise cash to survive. After all, the primary goal of listing on the stock market is the ability to raise capital. But when the stock prices are low, their hands are tight, as diluting the shares will further reduce the value of the shares.
As a side note, this is why we saw this much share dilution last year. Prices and liquidity were high, making the perfect condition for companies to raise more capital.
Rule #2. Think long term and DCA
Time in the market beats timing the market
Remain focused on your high conviction stocks over the long term. As it's tough to guess when the crash will occur or the market bottoms, dollar cost averaging (or DCA) will eliminate some emotions and prevent you from making impulsive decisions.
Buying the same amount every month will average your cost and increase your gains.
Let's look at the Nasdaq chart from the 2008 recession. The stock price fell more than 50% from top to bottom and lasted about a year and a half.
For example, let's say you started investing at the peak @55.02 and bought the same amount every month. The above chart shows you would have averaged your cost at around 39.62. Not only you break even faster in approximately 6-8 months compared to 3 years if you had stopped investing, but the money you invested in 2008 would be around 900% in profit in December 2021, 13 years later.
Time is on your side. Your job is to stay focused and stick to your plan. Investing is like planting a tree. They need time to grow until you can collect the fruit.
Rule #3. Diversify
Diversification won't make you a millionaire overnight. I've been through this last year while buying dividend stocks and missing out on all the juicy profits on tech stocks. Turns out my boring dividend stocks are the only ones keeping my portfolio from sinking to the bottom of the ocean.
This is because money has to flow somewhere. While other parts of the portfolio will sink, other parts will float and offset those losses.
Invest in dividend stocks and index funds, and build a solid core. You will thank yourself when stocks sell off like crazy during a recession.
Take a look at this article I wrote about how I build my portfolio:
Johannes Dragulanescu
Rule #4. Know your investments
When the crash comes, it will catch you by surprise. Everyone will panic and will start running around like headless chickens. The only way to keep emotions away is to understand the businesses you invest in. Do the research for all the companies you own. Learn their financials and strategies, and I guarantee you that the crash will no longer scare you.
You would feel the exact opposite. When I see my favorite companies on sale at 50% off, I get very excited. I can genuinely say that I now understand how it is to be greedy when others are fearful.
Imagine your favorite cake, video game, or laptop being on sale 50% off... would you be scared, or would you be so excited you jump out of bed and rush to the store to buy it?
If you don't have the conviction, you won't be able to contain the emotions. Don't just invest in companies because you heard about them on a Youtube video.
If you know the business and see that the company is doing better than ever and the share price is coming down, you're not scared.
Bottom line
Long-term DCA, have the discipline, diversify, keep emotions away, understand the businesses you invest in, and you'll survive 99% of the crashes out there.
Implementing those rules in your portfolio not only will protect you from any damages of a market crash but will also help you generate more wealth in an opportunity of a lifetime.
