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When you invest in assets, you can see your money grow and that's great. But there's a flip side to it: when you invest, you also risk losing money. Positive returns are never guaranteed.
This is especially concerning when you hear about the next market crash, the next economic downturn, the next time the bubble pops...
The Next Crash is Coming
If we look at the US stock market, on a long timescale, the price has been going up for many decades. But it's not a straight line up. In fact, downturns happen all the time.
At any given moment, we could be entering the next pullback, where prices go down for several months or even years and then take up to a decade to recover.
This has been happening since the beginning of markets and there's no reason to believe it won't happen again. This is why the "buy and hold", passive investing strategy has worked well in the past - but only on a long enough time frame. If you buy-and-hold for only 3 years, you could easily lose money. But, historically, if you buy-and-hold for multiple decades, you're always in profit.
Fearful Investing & Trying to Time the Market Crash
So much for the historical perspective. Unfortunately, the price movements and potential downturns are hard to deal with when we see them unfolding in real time.
There are wo ideas from legendary investor Peter Lynch that I find helpful in this context:
- The next market crash is always "about to happen". There are always experts warning of an impending crash.
- More money is lost trying to time the downturn, than in the downturn itself.
We've seen before how the fearful "monkey mind" leads us to losing money when we try to trade a market. The same is true for the macro - for the bigger picture. Fear can lead to bad investing decisions:
- Sitting on the sidelines with all your net worth in cash, waiting for the next crash - could be a good idea if you're lucky and you manage to "buy the bottom". But you could also be sitting there for years, missing out on lots of growth.
- And when the crash happens, how will you know when the bottom is in? Again, fear will lead you to miss out. You'll believe that prices are going to crash further and you'll miss out on buying at the lowest point.
- When prices go up again after a correction, fear will tell you that this isn't the real recovery yet - that this is a dead cat bounce and the real crash is still coming.
Is Diversification the Solution?
Maybe you've heard that you should always have a diversified portfolio. If timing a market crash doesn't work, is diversification the way to protect against economic downturns?
Technically, yes. Diversification lowers your risk and it "softens the blow" of an economic downturn.
This is especially true if you diversify into multiple asset classes such as stocks, real estate, bonds, cash, precious metals, commodities and crypto. Assets within an asset class will often move up and down more or less in unison, so having a portfolio of many different stocks doesn't provide as much protection as having a portfolio with assets across many different asset classes.
However, while diversification means you'll lose less money in a downturn, it also means you'll make less money during growth periods. In the video, we look at some practical examples of this.
A highly diversified portfolio is good for preserving wealth, but it does so at the cost of growth. Just as it protects you from downside risk, it also "protects" you from upside gains. Because of this, I think it is not a good idea to be highly diversified when the primary goal is to grow wealth.
Okay, so we've seen several things that don't work. What does work? What should we do, to not get wrecked in the next recession?
Choose a Strategy & Stick With It
Sticking with your strategy is the best approach, as long as the strategy was sound to begin with.
We've looked at passive investing with dollar cost averaging and the buy-and-hold strategy. Historically, this strategy has performed extremely well, if you stuck with it for long enough. If you keep DCAing during a recession, it means you're getting the benefit of the lower prices. With DCA, you will buy the bottom and you never have to worry about timing. And because your money is in great companies, the prices will recover eventually and you'll get the full upside of all that growth, since you've been buying on the way down.
With this strategy, you'll be back in profit even before markets reach new highs.
But only if you stick with it - and in a downturn, that's the tricky part.
Make Concentrated Bets With Strong Reasoning
For growth, concentrated bets are better than wide diversification. But we're not talking about extreme concentration or taking irresponsible risks.
New growth opportunities are always arising. If you're among the very first to spot them, you can make a fortune (think: people who realized the Internet was going to be a big deal, long before it went mainstream). But you don't have to be one of the first. You can wait for a trend to form and jump in when the risk is much lower.
Think about buying into tech stocks at any point in the last decade: it didn't take a genius to see that a tech revolution was unfolding and it was certainly not a highly risky gamble to buy stocks like Google, Apple and Microsoft.
With someone like that unfolding, should you really diversify into bonds that yield 2% a year or cash that loses 5% a year in value?
Get Exposure to Crypto, to Practice Weathering the Storm
In the stock market, market corrections of -30% to -40% happen every decade or two. In crypto, this kind of thing happens roughly every Tuesday...
Here's a look at Bitcoin price movements:
In Bitcoin, we've seen 5 events when the price went down by over 50% in value... just since 2013! That's not even the entire history of Bitcoin.
And yet, despite these violent price movements, the upwards trend has continued so far. In crypto, you can uniquely experience what would be apocalypse-level market corrections elsewhere, on a regular basis!
This is great practice for dealing with price movements and it can make you numb to big losses (and big gains) over time. Even if you don't want to put a lot of your net worth into crypto, I think it's worth getting some exposure, just for the market crash practice is provides.