“A stock market decline is as routine as a January blizzard in Colorado. If you’re prepared, it can’t hurt you.”
That’s what Peter Lynch wrote in his classic book Beating the Street.
It’s completely true. And I’m sure this advice played a major role in Lynch’s ability to beat the market 11 out of 13 years and post average gains of 29% per year.
Here are three moves we’re sure Lynch would advise making today that would have you greatly positioned either way stocks head from here.
Three Simple Moves Cautious Investors Should Make Now
There is a lot you can do to be in position for a market shock.
None of which require selling everything, buying gold, and pricing out a bomb shelter.
Three reasonable moves cautious investors can make:
Cash is King-ier
The one thing you must do is have cash on hand.
Remember, we want to be in position to enjoy a drop in stocks. But we don’t want to miss out on the next leg up either.
This is where you have to know yourself as an investor, know your risk tolerance, and keep a cash balance that would be right.
To determine how much cash you should have, just figure out how many years do you have to recover from riding out a downturn.
If it’s three years, you’ll want a lot of cash. Probably 50% or more.
If you’ve got 20 years, you won’t want much at all.
One thing most investors don’t consider much anymore is liquidity.
Liquidity is the ability to quickly buy and sell an investment at a good price.
With the implementation of high frequency (HFT) trading systems trading shares back and forth for $0.0001 profits and losses, the markets look incredibly liquid.
Most of that liquidity is just a mirage.
Remember the “Flash Crash”?
The Dow dropped nearly 10% in a few minutes and shares of Johnson & Johnson (JNJ) and other major companies were trading hands for as much as 90% below their price earlier that morning.
That’s liquidity, or more correctly, what happens when liquidity evaporates.
It will seem painful. You’re stocks are trading for far lower than what they’re worth. But if you are liquid when others aren’t, you can buy extremely cheaply (think 2008 bottom!).
Finally, the easiest thing you can do to ensure you’re protected form a market downturn is to always buy cheap.
We love cheap. And we look to buy the cheapest stocks in the cheapest sectors.
We do this to eliminate general market risk and reduce the impact of significant corrections.
It’s not a perfect strategy. After all, if the entire market gets crushed, there won’t be too many places to safely hide.
The prices of assets that have already crashed, however, will be far less impacted by a major market drop.
Think of the last housing bubble.
In Las Vegas there was ample supply of housing, plenty more under construction, and prices were soaring.
That market was great until it wasn’t. Prices fell by 50%+ across the board.
Meanwhile, the Detroit housing market collapsed too and not many noticed. A $1,000 house was still selling for anywhere from $1 to $1,000.
The same is true in cheap and expensive stocks. When cheap stocks are bought when they’re way down, no one wants them, and the problems they’re facing are temporary, they have a lot less room to fall than expensive high-flyers.
The High Cost Complacency
Those three bits advice allow us to rest easy regardless of what happens in 2015 and beyond.
There couldn’t be a better spot to be in either.
If the markets continue to climb, risks will climb right along with them, and you’ll want to be protected.
Of course, you also don’t want to miss out on the gains that are still left to come in the current market either.
Granted, it’s a tough spot to be in to get both of those. But managing that type of situation well is what separates the world’s greatest investors like Peter Lynch from everyone else.
In the end, through it all remember that Peter Lynch also wrote, “A [stock market] decline is a great opportunity to pick up the bargains left behind by investors who are fleeing the storm in panic.”
Take the three steps above and you’ll be in great position either way. And if you set it up right, you may even be hoping for a market crash.