[Updated in July] During the March Stock Market Crash pretty much all my family members and some of my friends asked me how to invest in stocks. Given the current market turmoil, there is an increasing appetite for buying stocks.
These are the 10 Rules they have learned should another crash materialize (e.g. should the liquidity problems turn into solvency problems in the wider economy later this year)
1. Invest in Stocks gradually on the way down
When and how to invest in stocks? If you have directly or indirectly prepared for a period of financial stress and have available cash you may consider starting investing when there is a market crash.
A good strategy is to build rules and stick to them — either based on certain index levels e.g. S&P 500 at 2700 invest 20% of savings, 2500 another 20% etc. or based on timing (slicing every few weeks since you will never have clarity which way the market may go and when it will bottom out)
2. Do not chase an upward trend in a bear market
One of the common mistakes we see is people chasing upward trends because of FOMO — Fear of Missing Out (when stock market recovers after a big crash for a few days giving hope of long term gains).
It takes more courage to buy according to predefined rules which often means buying when everything is gloomy and stocks lose massively. Buy on days when stocks are massively sold not bought. In the long term it pays off. Do not be tempted by rebounds that may prove short-lived.
3. Do not try to time the market
The market can turn rapidly both ways and while you may avoid some bad days avoiding just a few good days can be extremely detrimental to your long term performance as illustrated by a study done by Fidelity.
Also, it is extremely risky to use leverage since additional debt implies you must be correct on timing
4. Invest, do not speculate
You may not get spectacular 300–400% returns overnight but your money will be relatively safe if you base your decisions on sound financial statements and diversify. You can follow Wise Money with ETFs that are a great way to invest in indices without taking idiosyncratic risk (e.g. Luckin Coffee dropped 80% in one day in March on uncovered fraud — as Warren Buffett says “Only when the tide goes out to do you discover who’s been swimming naked”).
Ask yourself the question — am I more qualified than a professional investor to predict which industry player may outperform the rest of the market?
Do I know how the landscape post-crisis will look like? Even if you suspect knowing first-order effects are you sure of the second and higher-order effects (to Nicholas Taleb’s point)
5. Avoid binary outcomes
How to invest in stocks to avoid drawdowns? Each crisis has its own most vulnerable industries where outcomes can be binary — in 2008 some Banks went out of business and as an investor, you may have lost everything. The Coronavirus crisis has other prime candidates for such outcomes, airlines can be nationalized and hotel/tourism industry players can go bankrupt should the distress last longer. You want to avoid these investments until there is more clarity on consumer confidence
Since these recover now you may think it was wise to invest at some point but the key is that you can’t base the rightness of a decision based on an outcome but on a probability it would occur. And in March chances were high there would be lots of Airline Lehman Brothers (in fact, a lot materialized — LatAm, Virgin Australia, etc)
6. Look for financially resilient firms
If you do invest in single names, do not believe blindly in potentially meaningless dividend yields based on past data unless it has been confirmed by the management after incorporating all the outlook related to Covid-19.
Instead, look at balance sheets with low debt and build-in resilience (cash). These firms may outperform and even acquire weaker competitors in the current environment. Be cautious though, you can’t predict the impact of post-Corona market on Business Models
7. Keep Some Cash
Ray Dalio now infamously said a few months ago that ‘Cash is Trash’. While he is one of the best thinkers in Finance the remark was badly timed. Even in the most conservative scenarios keep some reserves. This is primarily a health crisis and while an economic crisis unfolds having a safety net is paramount.
Additional unforeseen tail risks always exist (think Oil Price crash or Trade War on top of Coronavirus etc)
8. Diversify in other assets including currencies, commodities and high quality debt products
It is difficult to predict which countries may relatively outperform. Keep your portfolio diversified geographically (e.g. Asia, Europe, US) and product-wise potentially including commodities like Gold that may outperform in low real rates / high inflation environments. Consider very high-quality debt products. Here is a good guide on how to protect your Stocks Portfolio.
9. Stay informed but remain cautious
Knowing how to invest in stocks is also about adjusting your strategies as there is more clarity about the outlook. But be very careful with financial experts and consensus — when you see opinions converging usually something else will happen
10. Duration of the coronavirus pandemic is key
The risks are still skewed to the downside (it can take significant time)
While there is a discount to peak market values and positive catalysts may materialize (most pharmas are working on Coronavirus vaccines and mitigating drugs) the time it takes and the change of behavior will alter the markets significantly
The impact on people’s health even when cured and society at large is at this stage still uncertain. Stay safe and healthy!
My fundamental reviews of Equity ETFs and Asset Allocation include:
- How to build a Long Term Portfolio for Financial Independence - Guide to creating a Smart & Simple Long Term Portfolios with ETFs
- All you need to know about International ETFs - including Developed vs Emerging Markets, Small vs Mid/Large Caps and country allocations with List of Best ETFs
- The Simplest Equity Portfolio - Comparison of Best Total World Equity Index Trackers
- How to pick the perfect ETF? - Investing in Europe is not quite the same experience as in the US but this guide will solve all your issues. Spoiler - don't use TER! (applies to US Investors as well)
- Which Assets do I need in my Portfolio? - Clean up your portfolio from assets you don't need. High Performance and low maintenance Asset Allocation Strategies
- How do I benefit from a market crash? - In the long run no crash (including Japanese style) can derail you if you do it right
- How to Invest for Short goals? - Medium Term Investing is more risky than long term portfolio - pay attention to the right asset classes
My fundamental reviews include:
- Spectacular Market Crashes - how much can you lose? How long will it take to recover? How to take advantage of the next recession
- What about currency risk? Should I hedge my Portfolio? - Hedge or not to hedge? Guide to hedging currency risk in your Equity and Bond ETFs
- Should you buy Gold? - Is it necessary to have an asset that generates no yield? What really drives Gold price?
- International and European Bond ETFS - For Long Term International Investors Bonds are key to protect their Equity Portfolios
- US Bond ETF Guide - Comprehensive Review of Blend Bond Funds, Treasuries, Corporates, High Yield, Inflation Linked, Muni ETFs
- Top 3 Corporate Bond ETFs - If you want to increase income buy these ETFs to invest alongside the FED [for US Investors only]
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