Despite improving investor sentiment since the 2020 stock market crash, the near-term prospects for many companies continue to be uncertain. Risks such as political challenges in Europe and the ongoing coronavirus pandemic could cause investor sentiment to come under pressure.
Furthermore, the stock market has always experienced downturns following its gains. As such, now could be the right time to start planning for a market decline through holding some cash and identifying potential buying opportunities that may become more attractively priced in the coming months.
The potential for a second stock market crash
This year's stock market crash was caused by the impact of the coronavirus pandemic on the world economy's outlook. Although investors may be feeling more optimistic about the economy's prospects, a number of threats could hold back its performance in the near term. For example, Brexit may mean that investors are more risk averse due to it being an unprecedented event.
Furthermore, factors such as weak consumer confidence and a lack of investment from businesses that have struggled this year could mean that economic growth remains disappointing in the near term.
Another stock market crash is also likely to be experienced at some point in future because the track record of the stock market shows that it does not experience perpetual growth. Ultimately, an event is likely to take place that causes investor sentiment to weaken in response to the prospect of more challenging operating conditions for a range of businesses. Therefore, planning for such an occurrence in advance could allow an investor to take advantage of it.
Preparing for a market downturn
Clearly, it is extremely difficult to know when a stock market crash will occur. However, taking steps such as holding additional cash could be a sound move. This may enable an investor to react more quickly and decisively to temporary market declines that can rapidly be reversed. Cash savings may offer disappointing returns at the present time due to low interest rates. However, buying undervalued stocks in a market decline may mean superior long-term growth for patient investors.
Preparing for a market downturn may also involve assessing future buying opportunities. This may mean creating a watchlist, for example, of companies that have solid financial positions and wide economic moats. Waiting for their share prices to fall in a market decline can require a large amount of patience and discipline. However, it can be worth it if an investor is able to buy high-quality companies at low prices.
Certainly, planning for a stock market crash may mean there is an opportunity cost in the short run as share prices could move higher. However, it could be a sound strategy to use over the long run, as market cycles are likely to remain in place in the coming years.
