one of the biggest reasons why so many people avoid investing in the stock market is because
they're scared that it's going to crash if you study market history you see that market crashes
actually happen on a semi-regular basis and you can bet that they're going to happen again
heck in my lifetime the stock market has crashed on four separate occasions so what
can investors do to prepare themselves for a stock market crash in this video we'll
walk you through exactly that my name is Brian Feroldi and my name is Brian Stoffel
thanks to quarter for sponsoring today's video all right brian walk us through it how should we
as investors prepare for a market crash well we can't just prepare one way we've got to prepare
and cover all of our bases that means we need to intellectually prepare we need to emotionally
prepare we need to financially prepare and because we're human and we can do all those things and
still mess up we need to put some guard rails in place but brian why don't you explain to us what
we mean when we say preparing intellectually i think the best thing to do is to look back
at market crashes historically and just see how frequent and common they actually are that helped
me as an investor because once i realized that market crashes and market declines are very common
it made them seem much less scary every time i've lived through them so if you look back at the
market history the stock market specifically the s p 500 falls about 10 percent from its recent high
about once every 11 months or so that's basically once per year if you look at 20 drops those occur
about once every four years or so 40 drops are even scarier but those only occur about once
every 15 to 30 years and 50 plus drops basically happen once or twice in your lifetime but it's not
uncommon for us humans to think sure that happened to other people but it won't happen to me and i'm
going to teach you real quick about negative probabilities using a rather crude example
of russian roulette in russian roulette there are six chambers and only one of them has a bullet in
it now let's use negative probabilities to find out what would happen if you played this game what
are your chances of negative probability not dying if you play once well the answer is 83 percent you
have an 83 chance of surviving and we know that because five empty chambers divided by six is 83
percent the flip of that is that you have about a 17 chance of dying in one turn but what happens if
we say you have to play twice here's how we figure out those probabilities i'll give you the answer
you have about a 69 or 70 percent chance of not dying if you play twice how do i know because
i take 5 6 multiply it by 5 6 it not happening times it not happening in other words you have
about a 30 chance of dying if you play two rounds of russian roulette let's up it once more let's
say you play five rounds of russian roulette this is dangerous because now your chance of
not dying if you play five turns or at least five is 40 that's five six times five six
and doing that five times in a row that's how we figure out that probability now the flip of that
means that if you play five rounds you have a sixty percent chance of dying from russian
roulette enough with the crude examples though let's move on to investing now we know that a
30 drop happens about once every 10 years so what's the chance of not having a 30 drop in one
year any given year it's 90 percent how do we know that well we know that in nine out of ten years
we don't have that drop nine divided by ten in other words you have about a ten percent chance of
having a 30 drop in any year let's take that one step further let's expand that to 10 years let's
say you're going to invest from now for the next 10 years what are your chances of experiencing
absolutely no 30 drops the answer is about 34 35 percent we got that by taking nine tenths times
nine tenths ten times or the flip side of that is you have about a sixty five percent chance
of having at least one of those gut-wrenching drops over the next 30 years but here's the thing
most people don't invest for just 10 years they invest for 30 years or 40 or 50 but let's use 30.
what are your chances of experiencing absolutely none of those gut wrenching 30 drops if you invest
from now for the next 30 years the sobering answer is you have a 4 chance of surviving
without experiencing that in other words you have a 95 to 96 chance of experiencing this
it is all but guaranteed knowing because of negative probabilities how guaranteed this is
it behooves us to prepare all right brian so that number clearly shows the longer we invest the
higher the percentage chances that we're going to experience a gut wrenching drop in our portfolio
the numbers clearly show that so what should we do to prepare emotionally well my number one
suggestion is to go back and read the headlines from the times when the market was crashing
because that gives you insight into how people were feeling in the moment and that's what matters
most what it's like in the moment here's what time magazine looked like in 1987 which was right after
the biggest one day drop in stock market history it was a wild week on wall street and people were
freaking out more recently during the great recession it seemed like crisis after crisis the
stock market was going down congress didn't pass a plan to bail them out so they plunged even more
the world seemed like it was teetering on the edge of financial collapse in the moment
or how about more recently in march of 2020 when fears of covet were widespread and markets
everywhere were in free fall so after we've seen how scary it was in the moment now's the time
where we can zoom out a little bit and see what happened after that was it worth being so scared
well take a look at what happened to the s p 500 in the wake of that huge drop in 1987. the stock
market was back to all-time highs within about 16 months and within five years investors were up 47
if they just held throughout that period if we go back to the great recession even if you bought in
before the market started free falling in mid 2008 you were made whole about two years later
and if you held for the next five years again 40 returns from the s p 500 or what about more
recently in the free fall of march of 2020 if you just held throughout the entire downturn
you were made whole within a matter of months and the stock market then went on to set new
high after new high and to give you an idea of how hard it is to know what's happening in the moment
look at this tweet that i put up where i said yes a rally will happen but this is the suckerest of
all rallies this isn't it and i made that call at the exact bottom i was 100 wrong in the moment you
don't know what's happening so the data is clear even if you buy right before a crash within a few
years you're going to be made hold but that doesn't mean that you should be reckless in
fact there are several things that we think you can do with your personal finances to help you
thrive in a market downturn brian i think the number one thing you can do to prepare is make
sure that you have lots of cash on hand now you'll hear a lot of investing professionals say that hey
that cash it's not earning anything you shouldn't do that but the fact of the matter is is when you
have cash especially when everything's hitting the fan that gives you flexibility it gives you
options and it helps you sleep at night it's been said by people who are smarter than us that cash
is the raw material of tomorrow's future returns but how much cash should you keep and how should
you deploy it our friend morgan hausell created this great table that shows how he is going to
deploy his cash in the event of a market crash for every thousand dollars that he has set aside
he has a preset amount that he invests in the market mechanically based on how far it's fallen
from its recent high for example if the market falls 15 he invests 220 of that theoretical 1 000.
if it then goes on to fall to 20 he invests 300 i love this kind of thinking you're thinking and
planning ahead of time about what you're going to do with your cash so that way you don't
have to make any decisions in the moment now to highlight his point what morgan did was he said
if you went back to 2004 and didn't invest and then once the great recession hit that's when you
put money into the market he showed that by 2013 you'd actually be doing much better even though
cash was just sitting in your bank account that whole time now we're not saying that's what you
should do because you can't predict the future but it is worth keeping something on the side
so that you can take advantage of such situations having cash on the sidelines definitely helps but
i think it's also a fantastic idea when times are good to focus on paying down your debt and
when i see paying down your debt i mean all of it credit card debt car loans student loans basically
take as much debt out of your life as you can when markets are crashing and your emotions are on the
line it's hard enough to think straight if you have a mountain of debt hanging over your head
that just makes it so much worse and one final thing we'd like to say is that if you can build
multiple streams of income you're making yourself more anti-fragile you're making yourself have
to worry less about where money's going to come from if times get tough because you've developed
multiple streams to be able to support yourself and your family before we talk about the final
way that you can prepare for a market crash we wanted to give a shout out to quarter with quarter
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make every interaction between companies and investors meaningful the first step in this
journey is to users interact with the company's content while they are listening it's a really
cool new feature they just rolled out if you're interested in giving quarter a try for free visit
the app store of your choice today and download it that's q-u-a-r-t-r thanks quarter for sponsoring
the video all right brian let's talk about the final way that we think investors can prepare
for a market crash and that's by setting up some guard rails for themselves what do we mean by
that well what we mean is is that you can do all the preparation in the world that we've already
talked about but again once you're in the moment it's hard to make these choices so set these up
beforehand things like a 48-hour cool down period between when you might freak out about needing to
sell something because the market's dipping and waiting to let 48 hours pass before you actually
hit that sell button you know brian since me and you are contractors for the monthly fool we have
a 48-hour cooldown period forced upon us we can't transact on any stock if we mention it publicly
in any way and i think that really helps both of us absolutely that single rule has probably saved
me more money than anything else unintentionally another type of guard wheel that can really go
a long way to help you during a market crash is a great community join twitter join the motley fool
join microcop club find other investors who share your investing philosophy that you can talk to
when things are not going well a good community is worth its weight in gold so really take the
time to cultivate that ahead of time so that you have people that you can lean on and trust when
you have an itchy trigger finger to sell finally it's really important to remember why we invest
in the first place there is nothing that should be in the stock market no money that you need in
the next three to five years for most people this is to pay for things like college or retirement
when the pandemic started i put that sign over my shoulder to remind myself
that none of this money was needed until i was at least 65 years old and that helped write my
mind to know that anything that happens today is going to look very small in the rearview
mirror well we hope these ideas can help you to survive the next market crash and if anything else
you can know that brian and i are going to be hurting right alongside you brian's out