If you're nervous about the current state of the stock market, you're not alone. After a sustained and rapid rise in stock prices, valuations look as though they may be a bit stretched. Valuations like these have often come before a market crash , which has a lot of investors worried. The big challenge, however, is that while it's easy to predict that a crash will happen, knowing when that crash will take place is a whole different story.
The best any of us can really do is manage our portfolio around the reality that the market doesn't always go up and that sometimes, it falls fast. You can't successfully invest if you're paralyzed by fear, but you can get yourself better prepared while continuing to put money toward your longer-term future. With that in mind, here are four investing strategies to help you navigate the stock market in 2021.
No. 1: Estimate the value of what you own
A technique like the discounted cash flow model can help you get a handle on what your stocks are really worth. That model simplifies things to focus on a company's ability to generate cash over time. Based on a reasonable estimate of the cash it will generate and the rate of return you need to take on the risk of investing in its stock, it will help you understand what a fair value is for its shares.
It's not perfect, as the numbers it generates are based on assumptions about the future. What it can do, though, is help you find a reasonable estimate of that value and recognize the key drivers behind it. That gives you something to compare against the company's actual progress over time and help inform your decisions on what to do with your investment capital.
No. 2: Keep an eye on your companies' balance sheets
In good times, it's easy to overlook a balance sheet. When times get tough, though, a solid balance sheet can be the difference maker when it comes to a company's ability to stay afloat. This is because its balance sheet represents the company's assets and liabilities — and most importantly, its ability to access cash if the lending market gets spooked.
Key measures to look for are the business' current ratio and its debt-to-equity ratio. Its current ratio measures its short-term assets (think cash and things that are usually easily converted into cash) compared to its short-term liabilities like its debt coming due within a year. The higher that number, the less likely the business will be to face a near-term cash crunch.
A company's debt-to-equity ratio looks at the totality of what it owns compared to what it owes. In this case, the lower the number (as long as it's zero or above), the stronger the balance sheet is. This number can help investors determine how much longer-term flexibility a company has if the debt market were to remain unfavorable for a long time. In addition, the healthier this ratio, the more likely that the company will be able to get new financing even in a fairly tight lending environment.
No. 3: Collect your dividends as cash
One of the best parts of owning dividend-paying stocks is that their dividends generally get paid based on the health of the underlying company, not the current whims of the stock market. That means that if you own solid, dividend-paying companies, you're likely to get some cash headed your way, even if you don't sell any of your holdings.
If you let those dividends pile up as cash instead of automatically reinvesting them, then when the market starts offering up bargains (as it often does during crashes), you'll have money available. That can be very useful in keeping you from having to sell one pick to buy another, especially if everything is falling during a generally down market.
In the event the market doesn't crash, well, those dividends are still as good as any other cash you have access to. You can always include them in an upcoming investment round. After all, by taking them as cash, they stay in your control, instead of being automatically recycled back into the company that's paying them.
No. 4: Keep money you'll need in the near term out of stocks
Money you know you'll need to spend from your accounts in the next five or so years does not belong in stocks. Neither does cash you should have socked away to handle an emergency that may happen at any time. If you've been a bit lax about following those guidelines, the market being near an all-time high can be a great time to liquidate elevated stocks to buy more conservative assets.
Being forced to sell stocks when they're down in order to cover your costs is a great way to run out of money. That's why it's always important to have something socked away in cash, investment grade bonds, or other conservative assets like CDs or Treasuries.
In addition to being able to keep you from having to sell stocks when they're cheap, having some sort of cash buffer can help you psychologically when the market is down. Individuals need long-term investment strategies in order to be successful in stocks over time. It's a lot easier to focus on the long term if you know you don't need the money you have in stocks in the near term. That can be helpful when, not if, the market moves against you.
Strategies to help you stay invested, whatever the market does
These four investing strategies are designed to help you stay invested, even if the market isn't cooperating. The reality is that if fear spooks you out of the market after a crash and you miss a few of its best days in a rebound, chances are that you'll be worse off than had you stayed invested throughout the mess.
By helping you get grounded in valuation and balance sheets, you can get more confident in your investments. By managing your dividends well, you can have more control over some of your money, even if the market isn't cooperating. And by keeping your stocks focused on the long term, you can better stomach short-term tough times that the market will throw your way.
If there's a catch to these strategies, it's this: They tend to work better if you implement them before the market crashes than if you wait until a crash to make them a reality. That makes now a great time to consider putting them in place. So get started now, and be better prepared for any volatility that may come our way.
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