A guide to surviving a stock market crash

Many experts believe the stock market bubble, which grew significantly after the onset of the Coronavirus pandemic, has finally found its pin. In fact, three pins are competing against each other right now.

The first pin is the US recession. US stocks fell sharply last weekend following a weaker-than-anticipated July jobs report, raising concerns about a potential recession.

The second pin is the fear of escalating conflict in West Asia. The assassination of a top Hamas leader has intensified tensions in the region.

The third pin is the unwinding of the yen trade. The Japanese yen was a very cheap source of money, with interest rates in Japan nearly zero. Borrowing in yen and investing globally in high-return asset classes like equities was highly lucrative. However, the Bank of Japan raised rates by 0.25% and issued a hawkish commentary on future rate increases. 

This has rattled markets, causing significant declines, especially in the Japanese market, which experienced its worst one-day loss in history.

These three pins each have the potential to burst the bubble, either individually or collectively.

Many investors believe India is decoupled from global markets due to low reliance on FIIs and exports. However, this may not be entirely true. India still runs a trade deficit and needs dollars to bridge the gap between higher imports and lower exports. Additionally, the Indian economy remains vulnerable to higher oil prices, meaning global troubles will impact India as well.

Unsurprisingly, as US and Japanese markets tank, Indian stocks are also struggling. While benchmark indices fell, small and midcaps declined more than their large-cap counterparts. Further damage may be in store in the coming days.

So, how should one navigate the current uncertainty gripping global stock markets? Should one remain inactive or sell everything and flee to the hills anticipating a major crash? The answer lies in preparedness.

Imagine a woman whose caravan breaks down in the middle of nowhere. Instead of panicking, she remains calm, enjoying the beautiful weather. Her calmness stems from having an emergency plan in place. She has enough water and food for a few days, emergency contact numbers saved on her phone, and the knowledge that fellow travellers will likely stop to help.

Similarly, facing a stock market crash, one has the option to panic or prepare a plan in advance. Having a plan keeps you relaxed and on track in your long-term wealth creation journey.

Here's my plan: My goal is to beat the benchmark index by at least 5% annually over the long term. To achieve this, I recommend investing ₹100 with ₹25 each in stocks and bonds or fixed deposits, as the bare minimum in each asset class. The remaining ₹50 should be allocated based on broader stock market valuations. If the market is attractively valued, the entire ₹50 can be invested in stocks, resulting in a 75:25 allocation favouring stocks. If the market is expensive, up to 75% can be invested in bonds or fixed deposits, with only 25% in stocks. 

Alternatively, one can opt for a 50:50 allocation if uncomfortable with only 25% in stocks. This allocation should be assessed annually.

While no plan can guarantee success in the stock market, this approach allows you to buy low and sell high, which is the right strategy for long-term gains. A portfolio of 20-30 stocks with sound fundamentals and reasonable valuations is ideal.

In conclusion, while the threat of a stock market crash is real, predicting its exact timing is impossible. It is better to remain calm and have a plan in advance. My plan, with at least 25% in stocks and bonds at all times and toggling between the two asset classes for the remaining 50%, is logical, simple to implement, and has a good long-term track record.

If you prefer a different plan, ensure it is simple to execute and allows you to buy low and sell high. Avoid plans that force you to buy near market tops and sell near bottoms.

Happy investing.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.

This article is syndicated from Equitymaster.com