Here's One Way You Can Always Be Prepared for a Market Crash

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With volatility making a comeback in September and October, many investors fear another market crash is looming. But worry not, there are strategies to help you cope with these periodic downturns. In this Motley Fool Live segment from “The 5” recorded on Oct. 1, Fool.com contributors Jason Hall and Jon Quast discuss one way to always be prepared.

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Jason Hall: The headline of the article, I’m going to do a screen share of it. I wrote it last July so July of 2020. Do you have enough cash for the next market crash? The reason I wrote this article is I wanted to walk people through a process and a plan of having a strategy of how to manage their own behavior and it’s different for different people.

But for me, I carry cash in two separate buckets. One is the bucket that’s in my portfolio, but there’s bucket that is for life. That is to cover for unplanned expenses. It’s called emergency savings. That’s money you have, if you lose a job, if your car breaks down, if you have a medical expense or something like that that you have to pay for. Or maybe it’s a great thing. Maybe your kid wins a trip and you have to come up with $100,000 to subsidize the expense. There’s those things that are unplanned.

Then you have planned expenses. You know when your kids are going to go to college, you know when you’re going to retire, you know when you want to buy a vacation home or you want to buy a house. Keeping cash for those planned and unplanned expenses.

Then there’s the other bucket which is money for investing. There’s your money that you put into that you regularly invest. Your every month, every quarter, every week, whatever your cadence is and then there’s your extra cash. Sometimes, it’s called dry powder. Thinking about the numbers is why I aggressively invested, Jon. I keep between five and 10 percent of my portfolio in cash. Again, that’s my portfolio that’s outside of my emergency savings money and my plan savings money.

What I do, is I take that money and again this a separate from my regular cadence of investing, my dollar-cost averaging, and the companies that I love that I want to own more of. If we see a 10 percent market sell off and we supposedly see them on average once or twice a year. Some years we don’t see any some years, we see three, I start looking for companies that I love that have fallen more than that. Because that’s when you can buy on the dip and it can work. Because good stocks fall more than they should for no good reason when every stock falls. I take half of that money during the 10 percent decline and I go buy companies that have fallen more that I love.

If we see a 20 percent sell off and we see those every 7-10 years on average. We might go 12 years and see none, we might go four years and see two. But on average about every 7-10 years. But if I see a 20 percent decline, I’m going to take half of whatever cash I have at that point and I’m going to do the exact same thing. If we see a 30 percent decline or more, which happen every 15 percent or so years on average, they happen far more rarely, I blow out all of my cash and I aggressively invest it.

Usually, I probably won’t catch the bottom because the market will continue to fall and will take time to recover. That’s where that dollar-cost averaging, putting new money to work all the time comes into play. I will continue to invest over that period of time. But I’m not trying to catch the bottom. I’m taking advantage of the data that tells me to be aggressive in those times is how you can augment your long-term returns. But I keep it a small enough amount of cash that it doesn’t hurt my long term returns. Too much cash you’re going to underperform the market because cash sucks as a long term investment. That’s the only way to put it. That’s how I think about it.

Jon Quast: Yeah, that’s great because if you’re trying to time the bottom, you won’t actually invest when it’s time to invest, because you’ll say, I think it’s actually going to get worse and so you wind up not doing it by having that benchmark. It takes out the subjectivity and gets you in the game when you should be in the game.

Hall: Yeah. Absolutely.