This year’s March stock market crash caught many investors by surprise. And so did the subsequent stock market rally. Indeed, at the time of writing, the FTSE 100 is up nearly 30% from its March lows.
Technically, this suggests the stock market has re-entered a bull market. Analysts generally believe that a gain of more than 20% from the lows marks a bull market, while a decline of 20% or more is interpreted as a new bear market.
However, while investor sentiment seems to have improved dramatically over the past few months, the coronavirus crisis is still rumbling on. This could cause further market volatility in the weeks and months ahead.
Yet another stock market crash
As the economic pain of the coronavirus crisis continues to mount, risks are growing for the stock market. The market cannot continue to rise forever if fundamentals continue to deteriorate. With this being the case, it might be sensible for investors to prepare for yet another market crash.
There are several strategies investors can use to do this. Some might decide to hold assets like gold or Bitcoin as an alternative to stocks. While these assets have their uses, they may not be the best to own to weather another stock market crash. When the market collapsed earlier this year, the price of Bitcoin and gold also fell.
Another strategy could be to hold cash. This may have some merits. After all, investors should always have some cash on hand to cover any unforeseen emergency expenses.
However, holding too much cash can hurt long-term investment returns. With interest rates close to record lows, investors may become worse off over time due to the effect inflation may have on cash holdings.
The best strategy to prepare for a stock market crash, in my view, is to own a broad basket of high-quality stocks with strong balance sheets, as well as some cash. It’s impossible to time the stock market. So it doesn’t make much sense to try.
Hedge your bets
Trying to predict when the next crash will arrive could be a waste of time. Indeed, while many analysts think one could be just around the corner, that’s not guaranteed. The market could continue to rise for the rest of 2020.
The best way to hedge your bets may be to own high-quality stocks while keeping some cash on hand to take advantage of a stock market crash if it arrives. Buying shares at low levels while they offer a margin of safety could generate significant returns for investors over the long run. Following such a strategy has yielded positive results in the past.
Although at present there are significant risks facing investors over the short run, in the long term, the stock market is likely to recover.
Therefore, buying a diverse range of companies today, and adding to positions if a second stock market crash arrives, could allow investors to increase the size of their financial nest egg over the long term.