Note: Post may contain affiliate links.

How to Invest Before a Stock Market Crash

Learn the warning signs to a 2020 recession and how to invest before a stock market crash

The sky is falling for the stock market lately. The worst three days of the year for the S&P 500 have all been in August and seven of the worst 10 days have been since May.

In fact, the market has gone from a roaring 20.7% gain on the year to a daily roller-coaster that would make 7 Flags jealous.

On the one hand, the sky always seems to be falling for investors. They love to climb a wall of worry to new highs…but there is some very real reason to be worried that the wall may come crashing down soon.

How should you invest before a stock market crash? What are some of the signals I’m watching for a 2020 recession that could bring the market down and what can you do to protect your money?

We’ll look at how to invest before a recession as well as a stress-free strategy for investors. I’ll also be sharing a link to a free webinar for a complete investing plan customized to your goals.

Why a 2020 Recession is More Likely than People Think

Economists are currently putting the chance of a recession in the next year at 35%…but then again, economists have a lousy track record of predicting recessions.

Research by Fathom Consulting found that of the 469 recessions since 1988, the International Monetary Fund has only been able to predict four by the spring of the preceding year. Worse still for investors, the IMF has never forecast a recession in a developed country with a lead of more than a few months.

Private-sector economists aren’t much better. Another study by Zidong An and Prakash Loungani found that private-sector economists have only correctly forecast five of the 153 recessions in 63 countries from 1992 to 2014.

So if you’re waiting on economic models to tell you if a recession is coming in 2020, good luck…and this is from a guy that worked as an economist!

The big news lately is the inversion in the yield curve, specifically the rate of the two-year Treasury is now higher than the 10-year Treasury. This signal has flashed before every recession in the last 50 years and has a perfect record with only one false signal.

A recession has followed the inverted yield curve by an average of 22 months, which would put the start of a recession in mid-2021. That’s just the average though and there have been three recessions in the last 50 years that started much sooner after an inverted yield curve.

But as investors, we really don’t care about a recession. We care about the affect of a recession on the stock market, so that’s what we should be looking out for over the next year.

Looking at the stock market, which usually dips well before an actual recession, we see a scarier picture for 2020. In three of the five recessions since 1980, stocks started falling from their peak almost a year before the recession started.

That means we could see stocks start getting slammed mid-2020 or even earlier.

There are other warning signs to a coming recession but the real risk is that all this becomes something of a self-fulfilling prophecy. The market is reacting to the inverted curve, selling off like a recession is coming. Companies see the stock market falling and start to rethink their hiring plans for the rest of the year. That causes unemployment to start rising which decreases consumer spending and pretty soon…we’re deep in a recession.

How to Invest Before a Stock Market Crash

Wall Street analysts are predicting a 20% gain on the S&P 500 for this year followed by an 11% return in 2020. If you’re taking that as a sign to stay fully invested in stocks, think again.

Not only are some of those warning signs flashing red for a recession but analysts are just as bad about forecasting market returns as economists. This research by Birinyi Associates shows the average analyst forecast in blue and the actual return on the S&P 500 in red. Analysts are perennially either way low on their estimates or they totally miss the stock market crash when it comes.

Stock Market Forecasts History
Stock Market Forecasts History

Investing before a stock market crash or recession doesn’t mean you have to time the market perfectly. After more than a decade of higher stock prices, now is the perfect time to rebalance your portfolio to take some risk out of stocks and find protection in other assets.

What I mean by rebalancing is looking at the amount of money you have in stocks, bonds and real estate compared to your total portfolio. For example, if you have a total portfolio of $50,000 with $45,000 in stocks and $5,000 in bonds, then you have 90% of your money in stocks and just 10% in bonds (and subsequently, nothing in real estate).

The reason this is important is because having too much in stocks just before a recession or market crash is obviously not a good thing. Millions of 50-something investors had almost everything in stocks when the market crashed in 2008, losing half their retirement savings.

Having money spread more evenly between stocks, bonds and real estate will protect you from the worst of a coming crash. You’ll still see your stock portfolio fall but your overall portfolio value will be protected by the other two investment types.

Another strategy to use before the coming recession might be repositioning into sectors that are not as expensive as the overall market. The chart below shows the forward price-to-earnings ratio of each sector of the economy.

Stock Market Valuations 2020

You can see here that the S&P 500 market index is trading at a price of 16.2-times expected earnings of the companies in the index. That’s a premium of almost 13% over the ten-year average at 14.8-times forward earnings. Some of the individual sectors are even more expensive with stocks in Information Technology trading for a 29% premium on their ten-year average.

But there are pockets of value still in the market with stocks of financial companies and energy companies trading below their long-term valuations. This isn’t to say that all financial or energy companies are good investments but there certainly does seem to be more value opportunities compared to the more expensive sectors.

Take this information and invest broadly across the sectors or look for best-of-breed companies within the value sectors.

You can also rebalance your portfolio to some of the traditionally-safe sectors and into cash before the recession. Research by Fidelity in the graphic below shows the average returns of sectors during a recession as well as how often the sectors produced a positive return.

Recession Investing
Recession Investing

You see that of the 11 sectors studied, five have produced positive returns during recessions with three of those sectors (Consumer Staples, Utilities, Health Care) all generating positive returns in 70% or more of the recessions studied.

How to Invest When You Just Don’t Want to Worry about It

This strategy may still be a little more market timing than many people want…and there’s nothing wrong with that at all. The vast majority of investors would do very well to invest in a diversified portfolio, make regular deposits and take a stress-free approach.

You still need to watch the amount of money you have in stocks, bonds and real estate though. After more than ten years of a bull market, most investors have way more in stocks than is safe.

For example, if you had a 50/50 portfolio of stocks and bonds in March 2009, you would now have over 75% of your portfolio invested in stocks. Stocks have returned an annualized 16.7% return while bonds have lagged with a 4.2% return over the period.

Having more money in stocks over the last ten years has certainly paid off but now it leaves you hugely exposed to a stock market crash. If we get another crash like the 2009 disaster and stocks lose half their value, your portfolio will fall off a cliff!

So even if you don’t want to use some of the strategies above, repositioning in different stock sectors, you still need to rebalance back to your target percentages in stocks, bonds and real estate.

If you aren’t sure what your target percentages should be in stocks, bonds and real estate, click on the link below to reserve your spot at my free Goals-Based Investing Webinar. I’ll give you everything you need to create a personalized investing plan for your goals.

Click to reserve your spot at this free webinar

Following your goals to invest will help you pick the right investments and give you the confidence that your plan will survive any recession. In that webinar, I’ll show you a simple rebalancing strategy that will protect you from the worst of any crash. You won’t freak out when stocks fall because you’ll have those other assets and you’ll be ready to take advantage of lower prices when they come.

Once you know the amount you want in stocks, bonds and real estate according to your goals. Putting together an easy investing strategy with some stock sector funds or even a few Vanguard funds will free you to do what you do best and not have to worry about the stock market.

Watch this video to see how I put together a simple portfolio that includes all the assets with just five Vanguard ETFs.

Investing before the next stock market crash or avoiding a potential 2020 recession doesn’t have to mean timing the market perfectly. While you may never know the exact day or month of the next stock crash, the changes you make before a recession can prepare your investments for protection and even growth.

Sharing is caring!

Speak Your Mind

*