Secrets to Making Money During a Stock Market Crash
A Time When Fortunes are Made
Thanks to twenty-four hour news cycles and the constant bombardment of social media, every piece of small data seems like a monumental reason to begin trading shares in your retirement or brokerage account. From the jobs report to natural gas inventories, one would think that even taking a break for a cup of coffee or to use the bathroom could potentially destroy the hopes of early retirement.
The powerful, undeniable truth often repeated in financial circles is that making a lot of money doesn’t require a high IQ, either in the market or in business. It takes ruthless cost control, a disciplined routine, and a focus on doing what is right for the long-term, sticking only to what you understand (or your circle of competence). Whether you are running a McDonald’s franchise or managing your 401k from your home office, perhaps Nobel prize-winning economic Paul Samuelson said it best: “Investing should be like watching paint dry… If you want excitement, take $800 and go to Las Vegas.”
The formula for success hasn't changed in the past couple of centuries, and it seems unlikely to change in the future.
The First Rule of Making Money During a Stock Market Crash
Buy shares of good businesses that generate real profits and attractive returns on equity, have low to moderate debt to equity ratios, that improve gross profit margins, have a shareholder-friendly management, and have at least some franchise value. These firms hold up better under stress, making recovery more likely, even if the share price declines by 75% or more.
The Second Rule of Making Money During a Stock Market Crash
Dollar cost average into and out of your positions, buying and selling at fixed rates and set amounts of money. This will allow you to avoid buying a position at a peak or selling it at a bottom. You're never going to be able to time the market, so stick to a routine policy of regular share accumulation or liquidation.
The Third Rule of Making Money During a Stock Market Crash
Reinvest your dividends because it will supercharge your dollar cost averaging program. The work of renowned finance professor Jeremy Siegel has shown time and time again that reinvested dividends are a huge component of the overall wealth of those who made their fortune investing in the market.
The Fourth Rule of Making Money During a Stock Market Crash
Keep your costs low. Though it may seem insignificant, but there is a big difference between earning 7% and 8.25% on your money. For a 25-year-old investing $5,000 per month into a Roth IRA with hopes of retiring at 65, the 7% rate of return will get him around $998,175 by retirement. The 8.25% return will result in $1,383,610 in wealth. That’s 38.6% more money, or $385,435! Place the difference into municipal bonds and you get an extra $17,000+ in after-tax income each and every year without touching your principal.
Think about that – the same investment, with only slightly higher returns, is going to get you an extra $1,400+ per month in after-tax retirement income without ever having to touch your portfolio. Before taxes, that’s about $2,300 in gross pay when you were working nine to five at your day job. Put another way, getting that extra 1.25% return over 40 years is like receiving a $27,600 pay raise during your working years. The big difference is that you won’t have to deal with scheduled hours, a boss, coworkers, or a commute to collect your municipal bond interest.
Why talk about a 1.25% difference? That’s the management fee charged by most actively managed mutual funds. An index fund just buys and holds a basket of stocks established to mirror an index – most often, the S&P 500 or the Dow Jones Industrial Average. With almost no maintenance expenses, the fund costs are a mere 0.12% of assets per year, or $120 for every $100,000 you have put to work! The two most popular index funds are offered by Vanguard and Fidelity (check the prospectus for the current expense ratios).
I’ve seen one major wealth management firm offer an S&P 500 index fund, that requires virtually no work, but charges a 1%+ expense fee each year. That’s 10x the cost of the Fidelity and Vanguard funds for a virtually identical product! You’ve already seen what the implications can be to your pocketbook over a few decades. Most investors don’t realize the importance of fees because the money is automatically deducted from the mutual fund itself. In other words, they don’t have to write a check so it's a case of “out of sight, out of mind”.
(For more information, read All About Mutual Funds.)
The Fifth Rule of Making Money During a Stock Market Crash
Finally, the last secret to building your fortune when Wall Street is in a storm is to create backup cash generators and income sources. This is one of the single most important things you can do to cut your risk. Even if you are an attorney earning $300,000 per year, or an actor making $2,000,000 per film, you are going to have a much more enjoyable life if you know that you aren't dependent upon your next paycheck to maintain your standard of living.
My personal favorite utilization of this method is legendary investor Warren Buffett's proven method for long-term financial success known as the Berkshire Hathaway Model. This is the way my own life and finances are structured, and it can make it far easier to amass the first few million dollars in net worth. In essence, you live off your day job, funding your retirement out of your regular salary. Then, you build other cash generators (e.g., car washes, retail stores, newspaper routes, a lifeguard job during the summer, patents, royalties, rental houses, etc.) that you use to build your investment portfolio.
That way, while you are doing your regular thing - going to work, picking up the kids, having staff meetings, and putting gas in the car - your cash generators are pouring money into your brokerage, retirement, and other investment accounts.
This can shave decades off your quest to financial independence, not to mention protect you if you happened to lose your job (in which case, you could temporarily pull the money out of the cash generators to pay your living expenses until you could find work again). Think about Warren Buffett. If Dairy Queen were to go bankrupt, he would still be rich from Berkshire Hathaway's ownership of GEICO. If it were to go down too, he still has Nebraska Furniture Mart. If that were destroyed, there's always Benjamin Moore Paints.
If they were wiped away, he could always fall back on Coca-Cola. If they ceased to exist, there's always American Express, the Washington Post, Wells Fargo, U.S. Bancorp, Johnson & Johnson, Borsheims, and MidAmerican Energy. Plus, he makes millions sitting on various Board of Directors. All of this started with a paper route that provided his initial capital more than seventy years ago. Learn from it!