Between war in Europe, inflation in the United States at 40-year highs, and backups at the ports making a mess of supply chains, there is a lot going on for investors to worry about right now. Any one of those problems could cause turmoil in the market. All three together provides a key reason that investing has felt a lot like walking on eggshells lately, even if the market has staged a bit of a comeback in March.
With that backdrop in mind, the answer to the question of whether the stock market is going to crash again is simple. Yes — it will crash again. The real questions, however, are “when will it crash?” and “what can you do about it?”
The tougher question — when will the market crash again?
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Although it wasn’t exactly hard to predict that 2022 could turn into a challenging year in the market, a key reason the stock market opens most weekdays is that nobody really knows what will happen. The buying and selling of stocks is what drives market moves — and the emotions of the day can rule over long-term fundamentals for quite some time.
That makes forecasting when the next market crash will happen good for generating clicks, but not so good when it comes to trying to make changes to your portfolio just before that crash happens. If you guess wrong and the market keeps climbing, you’ll be missing out on serious gains. Even if you guess right, you’ll still likely be exposed to a major tax bill. That could take away a big chunk of the money you’re trying to protect in the first place.
Even if predicting when the market will crash again is a very difficult thing to do, recognizing that it will crash at some point still provides a very valuable investing framework. By planning around that distinction between whether and when a crash will happen, you can find a balance point that works in most market conditions. In essence, with a decent strategy, you can set yourself up to take advantage of long-term growth while still protecting yourself from the short-term pain that crashes bring with them.
What can you do about a market that will crash at some point?
Because you can be pretty sure the market will crash but can’t be sure when it will happen, you should set up your finances in a way that you don’t need to rely on stocks to cover your near-term costs. That means you’ll want a three- to six-month emergency fund to cover your costs temporarily if your other sources of income unexpectedly dry up. It also means you’ll want around five years of the expenses that you expect your portfolio to have to pay for to be held in safer investments than stocks.
That doesn’t mean five years of your total living expenses — unless you really plan to cover 100% of your expenses from your portfolio. If you expect a pension, Social Security, a salary, or some other fairly reliable source of cash to cover some or all of your costs, you don’t need that five-year buffer for the expenses those things will handle.
The trade-off you face is that money in more conservative investments like bonds, CDs, or cash will probably earn lower returns over the long haul than money in more aggressive investments like stocks. As a result, there’s a balancing act you must manage with that more conservative money.
You want enough of a buffer so that you can handle a typical bear market without being forced to sell your stocks to pay your bills. At the same time, you don’t want so much invested conservatively so that you lose the ability to get the potential growth to cover your longer-term costs as inflation rears its ugly head.
That’s what makes five years a decent target. If you’ve got enough saved up to enable a retirement somewhere around 20 years long, it means you can still keep a large enough stash in stocks to help with those later years. At the same time, if the market crashes early in your retirement, you’ve got that buffer to give your portfolio a chance to recover before you need to sell your stocks.
Start putting your plan in place today
With a decent emergency fund and a reasonable expense buffer, you can give your stocks their best chance to work their long-term magic, while still being able to handle the short-term pain from crashes. That’s a wonderful spot to be in if you expect the market will crash again at some point but aren’t quite sure exactly when that will happen.
Recognize that it will take time to get your finances to the place where you can make it through a typical market crash and emerge stronger on the other side. So get started now, and improve your chances of being ready the next time the market crashes.
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