Money Sundays: How To Invest During Stock Market Corrections

Readers, this is a post I wrote up for my Facebook feed during another heavy stock market selloff a few years ago. Given the recent stock market correction, I thought I'd share it here, edited and updated slightly.

I've been asked by a few people how I invest personally during truly bad stock market environments--uh, for example, like the current one. I thought I'd put together a note to share my process with readers, particularly those readers looking to become more sophisticated investors. Thoughts, reactions and feedback are welcome!

Before we get started, please keep in mind these caveats:

a) Your mileage may vary.
b) I give bad advice sometimes.
c) Do not fixate on the specific dollar amounts discussed below, and do not compare your financial situation favorably or unfavorably to them. View the numbers as mere examples to illustrate a process, nothing more.
d) No yes-butting.

Okay--here's my process:

1) First, make sure you have--at a minimum--two years' worth of expenses saved somewhere in an emergency fund that is totally separate from money you intend to put into the market. If you are worried about your job, are retired, or you don't have any alternate income sources, make that FIVE years' worth of expenses. If you can't meet this test, forget about investing in stocks. You need to save more money first.

1a) You cannot be fully invested now. If you are, you've already screwed up. You need to have additional cash available beyond the money in your emergency fund and beyond the stocks you already own.

2) Create a "shopping list" of dividend-paying stocks that you would like to own, with an investment holding time frame of 5-15 years (yes, I'm serious. Five to fifteen years). Diversify across sectors, choose leading companies, look for dividend yields of 2.5% to 5.0% depending on the sector. Consider including one highly-regarded, dividend-paying bank and one highly-regarded, dividend paying industrial company. When heading into a market downturn, you always want to have a shopping list ready and waiting with buy ideas.

3) Next, choose stock market levels at which you will gradually put your money to work. For me, I choose arbitrary levels of the Dow Jones Industrial Average: 16,000, 15,000, 14,000, 13,000, etc. Allocate your non-emergency cash in fixed and smallish amounts at each level as the market breaches those levels. You can choose other market benchmarks if you prefer, or choose levels of the stock market of your own home country.

What works for me is to create six or seven stock market levels. As the first few levels are breached, I put 5-10% of my cash to work. At progressively lower levels, I invest larger and larger portions of that cash. Continue this process as the market continues to fall.

Let's go over an example: Let's say you have $50,000 in cash (again, this in addition to your emergency fund) that you would like to put to work in the stock market (edit: once again, don't get hung up on this specific dollar amount or compare your available cash amount favorably or unfavorably to it, just consider it as an example). Thus at the Dow 16,000 level (uh, like last Friday), put ~$2-3k to work by buying shares of one or two stocks on your list. At Dow 15,000 do the same: invest another ~$3k in a couple of other stocks from your shopping list. At Dow 14,000, put $5-6k to work into 2-3 stocks. At Dow 13,000 another $5-6k. At Dow 12,000, put $7-10k to work, at Dow 11,000 another $7-10k. And so on.

You can see how as the market gets lower and lower, this process forces you to gradually commit larger and larger sums of fresh capital. If we really head into a serious shitshow, and the Dow breaches, say 10,000 (this would represent an enormous correction of nearly 50%), you will have only put about $25,000-$30,000 of your $50,000 in capital to work. Yes, you will have bought all the way down, but you will still have substantial available money to continue buying at market levels that will probably be at or close to a bottom.

A few final notes: Using this process, you will be separated from your money, at first, during any really big market crash, but it will protect you from committing too much capital too soon. Further, if the market recovers, doesn't crash, and never breaches these lower levels, you'll have automatically put at least some of your capital to work at relatively attractive prices--certainly better prices than anything the market's been offering investors over the past several months.

A few words on fear and emotion. No one ever said this game was easy. Even when you do have excess cash available to put to work at very low market levels, the palpable fear you and other investors will feel still makes it very difficult to actually put that money to work. Be ready for this, and keep extra pairs of underwear handy at all times. Rely on the discipline of this process to help you overcome fear and panic, and you will make investments that--in several years--you'll be ecstatic you made.

Most investors are either too arrogant or too fearful. Some of us think we can nail the bottom, others panic and can't help but get in and out at at exactly the wrong times. This process is based on accepting, with fundamental humility, that you cannot know the future, nor can you know where or when the market will bottom. It may bottom much lower or much higher than you think. This process will help you put modest amounts of money to work on the way down, and yet you will hold back extra cash in case things are far worse than you expected.

Finally, this process is guaranteed to prevent you from making the standard retail investor mistake of getting sucked into stock markets at the peaks of bull markets and then getting shaken out at the bottom of bear markets. This method insures that you gradually step deeper and deeper into the market at juicier and juicier prices.

Make sure you are always liquid and in a position to deal from strength as the market declines. Nobody ever made a dime panicking, and you can't make good investment decisions if you are already fully invested in a falling stock market.

Read Next: Recommended Investing Books and Becoming a Knowledgeable and Sophisticated Investor: Six Tips

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