History suggests that a stock market crash, or a 20% decline in the FTSE 100, occurs once every seven years. Since the last one was March 2020, there is no chance of a major accident happening anytime soon (if we go by the historical average).
However, minor pullbacks often occur on the FTSE 100. Data suggest that 5% or more occur 1.5 times a year in futsal. With the latest 5% drop in the FTSE 100 in January 2021, some may argue that there is a minor decline. While the 5% drop is rarely a ‘generational buying opportunity’, it would be a great time to pay cash to work.
So how do I prepare for the FTSE 100 price cut and benefit from it?
Keep cash reserves
Considering how volatile the FTSE 100 can be, I always keep 5% to 10% of my portfolio in cash. This percentage changes based on my view of the market and whether it looks cheap. For example, cash reserves typically fall by 5% or even 0% when the market declines significantly. Meanwhile, when the market looks expensive, this cash reserve could increase by up to 10%.
Keeping cash stocks provides psychological benefits. I stay calm when the market goes down even though I know I have a cash buffer, because I can buy and keep my position average.
Minor corrections or crashes on the FTSE 100 are usually associated with a scary headline and panic-selling reason. If history is a good indication, it is usually wise to ignore and invest in these titles.
An excellent example of this was in 2015, when concerns about the recession in the Chinese economy caused commodity producers to reduce their share prices. This event led to a 15% decline in the FTSE 100, as did product manufacturers Anglo American Falls above 30%. This fall drove many unprepared investors out of the market, only to see the FTSE 100 reach new heights a year later.
The moral of the story is that it’s usually better to stay in the market and invest a lot. For individual stock investors, this helps businesses understand exceptionally well. It helps me calm down and invest when the share price drops significantly.
The last row
While the FTSE 100 is not likely to crash 20%, a small 5% drop is reasonably always near the corner. To prepare for minor corrections, I have a wish list of companies that I would like to buy at a lower share price, keep a cash reserve, and stay calm when it happens.
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Harry Godfrey has no position in any of the shares mentioned. Motley Flower UK has no position on any of the shares mentioned. The opinions expressed in the companies mentioned in this article may differ from those of the authors and therefore the official recommendations we make on our subscription services such as Share Advisors, Hidden Winners and Pro. Here at The Motley Flower we believe that considering a variety of insights makes us a better investor.