Is a Market Crash Good or Bad for You?
Think I’ve fallen off my rocker for even asking? Well, consider this.
When saving for a long-term goal, such as financial freedom, a steady market rise can mean lower earnings. This happens as you continue to invest over time. This happens because you are buying at higher prices.
If the market drops by 20%, you can buy the same-quality investments for less.
Stock Prices and Company Value
Stock prices represent a company's value as determined by the market. They reflect the results of trades from that particular day and may not always be accurate. We can't determine the correct value either, so don't think you can time the market. You can’t.
Stock prices will change over time. They will hover near the true value of the company. Sometimes prices will be higher, and sometimes they will be lower. So, if you are in saving and investing mode, would you rather stock prices today be:
- Over the true value
- Under the true value
Under, of course! That’s exactly what a market crash represents.
Why Diversification Matters
To benefit from this, you need a diverse portfolio of companies. Aim for thousands, not hundreds. Individual companies may go out of business, but it’s unlikely that all of them will at the same time.
This is why we only invest money we know we won’t need for many years. We also invest in a portfolio with the right risk structure. This helps ensure the portfolio doesn't drop too far for our comfort level.
The trick is to structure your portfolio to match your personal patience level. This way, you will feel good buying stocks on sale when a crash occurs. You can be confident that you can fund your needs until the market recovers.
If you can wait through declines and keep investing when stocks drop, great returns are ahead!
So, what do you think?
Do you see the market as being “on sale” when it drops?
Do you think the stock market will rise by the time you need your money? It doesn’t matter what happens in between.
Do you have an emergency fund that’s the right size? Also, do you have extra money for big costs in the next 5 years?