Your 3-step cheat sheet to prepare yourself for the next bear market

We all know that the stock market moves in cycles. What goes up has to come down and what comes down, has to go up. 

According to data from the National Bureau of Economic Research, an American private non-profit research outfit, the average duration of a full market cycle (from peak to trough to peak) from 1854 to 2009 was once every approximately five years. During that period, there were 33 such market cycles. 

From 1945 to 2009, there were 11 boom-and-bust cycles, which averages to one every roughly six years. 

You may know where I'm leading to. 

June 2009 marked the end of the Great Financial Crisis (GFC) that started in December 2007. From the 2009 recovery till now, there hasn't been a major crash; we've only seen small dips here and there. 

Therefore, is it ripe for a stock market crash? 

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That's precisely the question one of my colleagues asked me on Wednesday over lunch. My reply was that I don't know when exactly a bust will happen as averages are just that, averages. But one thing I know for sure based on history, and that's markets will crash.

So, should we shun the stock market entirely out of fear, which could be to the detriment of our financial goals, or should we be better prepared for the next crash? I think the answer is obvious, and that is, we have to prepare ourselves for the inevitable. 

Here, let's look at three simple steps on what we can do to attack the bear head-on when it rears its ugly head. 

1. SAVE SOME MONEY TO DEPLOY IMMEDIATELY  

Some investors might argue with me on this, but I'm a firm believer of not being fully invested in the stock market at any one point in time. I feel it's safer to have some ready cash chucked aside somewhere to deploy quickly should a stock market crash happen. 

During the GFC, Singapore's stock market benchmark, the Straits Times Index (STI), plunged around 60 per cent. The STI brought down many fundamentally-strong companies together with it. If one had the funds and the stomach (more on that later) to buy the companies that were selling at rock-bottom prices, the investor is most likely to be sitting on huge gains right now. 

The extra cash can also be used to buy more of a company's shares that we already own. If the reason why we purchased shares in the first place still holds true, it becomes even more compelling to buy them after a market crash, provided the reasoning is intact. 

The 2007-2009 stock market crash gave a once-in-a-lifetime opportunity to load up on great companies. We can never accurately predict when such a stock market crash will happen next. But if it happens, we need to have the cash to act.

2. HAVE A SHOPPING LIST WITH THE EXACT "BUY" PRICE 

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Let's say the stock market were to crash tomorrow, and you know theoretically that you have to deploy the funds to take advantage of the falling stock prices. Would you readily go and buy stocks, or do you think there would be a psychological block? 

I think the latter is more of what might happen in general. 

Loss aversion, which refers to our innate preference to avoid losing compared to gaining the equivalent amount, might make us wait till "the market recovers". But when the market recovers, it might be too late to buy shares on the cheap. As Warren Buffett famously said, you pay a very high price in the stock market for a cheery consensus. 

Therefore, to overcome this psychological bias, we should always research on the stocks we like beforehand with the price that we would be comfortable to buy at. 

Also, with such a shopping list, we would have a clear mind on the exact stocks we wish to add to our portfolio instead of being side-tracked by the various opportunities that the market might present during a market downturn. 

3. TAKE MASSIVE ACTION DURING A STOCK MARKET CRASH

"Be fearful when others are greedy. Be greedy when others are fearful." - Warren Buffett

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We can prepare all we want, but during a stock market crash, if we don't act, all the preparations would be futile. 

The shopping list that we've created would come in handy for us to act from a logical perspective instead of having our emotions drive our actions.

We will not know for sure when the market would bottom during a crash, so it's not advisable to go all-in as the bear market begins. However, if we invest a certain amount every few months consistently as the market declines, we would have bought enough stocks at a reasonably low level. 

Remember, a wise man once said that the stock market can remain irrational longer than you can remain solvent. You don't want your dry powder to be used up within a short period and end up not having enough funds to take advantage of further price falls.

Always bear in mind that the stock market and the economy work in cycles. So, when you take action during a downturn, you would be rewarded handsomely during the upturn, provided you buy the strong companies. In fact, there are stories abound of millionaires being created after a stock market crash as they dared to take massive action when there was blood on the street. 

This article was first published in Seedly.

All content is displayed for general information purposes only and does not constitute professional financial advice.