How to prepare for and react to a stock market crash

Uncertain times are upon us, and it takes bravery to keep an investment portfolio steady. But those who are willing to hold out and buy in the downturns will inevitably profit from them.

Regional tensions, an uncertain euro, the Ukraine situation and a looming Chinese property crash all worry investors. Carl Court / Getty Images
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Volatility is a fact of life for investors right now, as one crisis after another threatens stock markets.

Tensions in the Middle East, the euro-zone crisis, conflict in Ukraine and the threat of a Chinese property crash are all keeping investors on their toes.

Currency wars, plunging oil prices and negative interest rates all confirm that we live in unpredictable times.

UAE expatriates are exposed to the financial fallout, because when markets fall so does the value of their investment wealth.

Be warned, because the volatility looks set to intensify, says Maike Currie, an associate investment director at Fidelity Personal Investing. “Memories of the devastating slide in financial markets in 2008 are starting to fade as investors enjoy the subsequent six-year bull run. But as bull markets mature, volatility tends to increase. That doesn’t mean the ride is over, but it is likely to get bumpier and investors should be prepared for ups and downs.”

The problem is that nobody can accurately predict exactly when share prices will tumble.

While doomsayers have been predicting another wipeout for the past six years, global market indicators such as the S&P 500 in the US and London’s FTSE 100 have flown to record highs.

Investors cannot just sell up and sit things out until the world has solved its troubles, because it never will. But there is plenty you can do to protect yourself from a market correction or crash.

James Thomas, managing partner at the independent financial advisers Acuma in the UAE, says how to respond when markets crash is the billion-dollar question facing every investor, and there is no easy answer.

Don’t fool yourself into believing that you can see what is coming and get out in time. “The simple answer is that it is almost impossible to eliminate the danger by correctly timing the stock market.”

Even the finest investment minds cannot consistently call stock market movements because there are just too many variables, he says. “Oil is a good example – recent dramatic price falls have had a negative effect on oil company stocks, but have also been good for consumers who pay less to fill up their cars, helping the global economy.”

Markets are also full of surprises, making them difficult to predict. “The Russian rouble fell dramatically when oil prices fell, but it has been one of the best-performing currencies this year, strengthening significantly against the dollar,” Mr Thomas says.

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If you do pull your money out of the market, you then have to decide when to pay it back in again. If you get your timing wrong and share prices rise instead of fall, you may end up buying back into the market at a far higher price, Mr Thomas says. “Missing just a few days of market growth can have a huge impact on the overall return on your investment portfolio.”

Anybody who sold their shares after the market hit its post-financial crisis low in March 2009 would have missed out on a dramatic rally in which global markets rose 50 per cent in just six months.

In times of trouble it pays to keep your nerve, says David Norton, the head of investments at the expatriate financial advisers AES International. “Usually the best option is to do absolutely nothing, simply ride it out and wait. It may be an uncomfortable ride and the recovery could take some years, but markets always get there in the end.”

You can reduce the short-term impact by using what the professionals call asset allocation – putting your money into a spread of shares, bonds, cash, property and specialist investments.

Mr Norton says: “If stock markets fall or property prices crash, a diversified portfolio that has exposure to safer assets such as gold and cash will give you some security and reduce the fallout.”

Physical assets such as bullion, coins and property give you emotional security, Mr Norton says, but they pose risks as well. “Although the value of cash won’t plummet in the conventional sense, it will still be eroded by inflation over time, reducing its value in real terms. And as the financial crisis showed, banks aren’t as secure as many assumed.”

Adrian Ash, who runs the specialist desk at the online gold and silver market Bullion Vault, says many investors use gold as insurance against a stock market crash. “Gold’s rarity gives it an emotional appeal and its indestructible nature stands in stark contrast to currency, debt or equities.”

Mr Ash says gold typically performs well when stocks slide, and poorly when stocks surge. It duly soared to a high of more than US$1,900 an ounce as the euro crisis panicked investors in August 2011, but fell as markets rebounded in 2013, and now trades at under $1,200.

Do not put too much faith in gold, because as those figures show it can be just as volatile as stocks and shares. You should only invest in gold as a small part of a balanced portfolio.

Every investor needs to work out exactly how much investment risk they are willing to take, and make sure their portfolio reflects that. If the thought of what a market crash will do to your portfolio gives you sleepless nights, you should switch money into more cautious investments such as bonds and cash.

Tom Elliott, an international investment strategist at the independent financial advisers deVere Group in the UAE, says once you have built a portfolio that reflects your risk profile, you should review it regularly to make sure the balance is still right.

If stock markets rise, for example, you may have more money in stocks and shares than you feel comfortable with. “You should rebalance your portfolio every six to 12 months by forcing yourself to sell your winners and buy more of your losers, to maintain the same overall balance of assets.”

By selling high and buying low, you can take advantage of how last year’s winners often turn out to be this year’s losers.

Mr Elliott says: “This strategy also prevents you from becoming too overweight in this season’s favourite theme, which would make your portfolio vulnerable when market sentiment changes.”

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Private investors have one big advantage over the professionals, Mr Elliott says. “Nobody will judge you on your quarterly performance, which means you can afford to sit out the market peaks and troughs, and keep your eye on the long term.”

Many investors get particularly nervous when putting new money into the market, in case share prices crash soon afterwards. In this case you can protect yourself by drip-feeding regular monthly sums rather than making large one-off investments.

By investing every month you can also turn market setbacks to your advantage because of something called dollar-cost averaging, Mr Elliott says. “If share prices fall you will buy more stock for the same monthly payment, so periods of distress actually work in your favour, provided markets recover by the time you cash in your portfolio.”

Ms Currie says another way to reduce the highs and lows is to invest primarily in top-quality companies. “In uncertain times people will pay for certainty, and this tends to favour companies that can demonstrate sustainable growth, operational diversity and good management. So look for mutual funds focused on companies with strong balance sheets paying attractive dividends.”

She says you also need to take a long-term view. “Short-term volatility is the price you pay for the long-term outperformance you get from the stock market, so don’t be scared away.”

Ms Currie says you have to keep calm and carry on, because although corrections are painful they do not last forever.

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Stock market crashes do the most damage to people who are just a few years or months away from retirement, as they have little time to recover their losses. Expatriates in this position should therefore reduce their exposure to shares in the final years before they retire.

But sharp-eyed investors with time on their side are on the alert for stock market dips, because this gives them the opportunity to load up on their favourite shares and funds at temporarily reduced prices.

Ms Currie says: “Since 1950 the US stock market has fallen more than 13 per cent in a three-month period 24 times. On 15 of those occasions the market bounced back by at least 20 per cent over the following 12 months.”

If you have the courage to grit your teeth and buy on the dips, volatility gives you the chance to top up your portfolio at reduced prices.

For many long-term investors stock market dips are not a threat at all, but an unmissable buying opportunity.