If a Stock Market Crash Is Coming, Here's the 1 Thing You Shouldn't Do, According to History
Key Points
Several valuation metrics indicate that the market is trading at high levels today.
Investors might be tempted to pocket gains at these levels.
But great stocks can continue to create shareholder value over time.
Is a market crash coming? What investors really want to know is whether a market crash is coming soon; there's sure to be a market crash at some point, but the unknown is whether it's around the corner or far off into the future.
There are certainly signs that it might be sooner rather than later. The S&P 500 (SNPINDEX: ^GSPC) is trading near its highest valuation ever as measured by a cyclical-adjusted P/E (CAPE) ratio of 41, and when it hit its record of 44 in 2000, the market crashed and lost value for three years straight.
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The Buffett indicator, which measures the total stock market value relative to U.S. gross domestic product (GDP), is at 240%, implying that it's highly overvalued.
There are several ways you should prepare for the eventual event, especially since it could be close by. Make sure your portfolio is diversified, own a selection of defensive stocks, and keep cash on hand to grab bargains. Here's one thing you should not do.
Buy, hold, and....hold
It could be tempting to sell stocks as they near highs. But as soon as you sell, you lock in the gain and close out the opportunity to gain even more. If you ask successful investors what their biggest mistake was, you're likely to hear from many of them that it was selling too soon.
Here are a few examples of when it might have looked like a good time to sell top stocks, and what happened years later.
- Netflix went public in 2002, and 15 years later, it had gained 14,500%. However, if you'd held on for nearly 10 more years, it would have gained 67,000%.
- Apple stock dipped during the 2008 crash, and if you'd bought it on the dip, you might have been tempted to sell it 10 years later, when it had gained more than 800%. If you didn't, it would be up 5,000% in total.
- Nvidia was a popular gaming technology stock that had gained more than 10,000% from its initial public offering (IPO) in 1999 through 2017. But if you didn't sell at that time, your money would now be worth 500,000% more since the IPO.
These are some of the best gainers ever to demonstrate the point, but many other stocks follow a similar trajectory.
Water your flowers
Warren Buffett likens selling great stocks too early to cutting flowers, and he said that Berkshire Hathaway is the opposite of investors who sell in a hurry and book profits. He said that at the same time as his famous maxim that his favorite holding period is forever.
Historically, the market has always reached new record highs after crashes. Sometimes it's a quick recovery, and sometimes it's slower, but it's always happened. In 2020, the S&P 500 lost nearly 30% of its value in about three weeks, but it had completely recovered within another eight weeks, and it's gained 240% since then.
The caveat is that if you'll need your money very soon, you might want to pocket some gains while the market's at a high and the chance of a crash grows. But if you have a long time horizon, let your top stocks flower.
Jennifer Saibil has positions in Apple. The Motley Fool has positions in and recommends Apple, Berkshire Hathaway, Netflix, and Nvidia. The Motley Fool has a disclosure policy.