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How to Invest Fearlessly When Markets Crash

The Straits Times Index (SGX: ^STI) is on a good run this year, increasing 7.5% this year up till 10 November 2014. The ride up for the index this year has been relatively smooth, despite a brief dip of about 7% for the SPDR STI ETF (SGX: ES3) in October. The SPDR STI ETF is a proxy for the STI.

While the index is experiencing a bountiful year, there may be no better time to “make hay while the sun shines”. Or in Singapore parlance, prepare the umbrella before it rains.

As certain as rain drops will fall in Singapore, market corrections will occur from time to time in the share market. With that in mind, here’s a couple of things you can do to prepare yourself to invest fearlessly during a market correction.

Prepare a “cash cushion

Well, no — it does not mean that you should stuff your money into that small pillow on your sofa. That said, while the share market is looking sunny and bright right now, it may be the best time to gradually start building up a cash position to prepare for the next market correction.

To do this, the Foolish investor can consider putting aside part of their savings each month to build up a cash position. This cash position can be built up to 10% or 30% of your total share portfolio. The key here is to really maintain whatever cash allocation percentage that makes you feel comfortable — if the share market corrects unexpectedly.

This cash position – or as I call it, “cash cushion” — is something that can provide you with valuable capital to take advantage of market corrections. More importantly, I have also found that having cash on your hand when the market inevitably corrects has a calming effect on the investor as well. If you can remain sane when everyone else is jumping off the share market (during a correction), you may find courage to invest fearlessly.

Use smaller positions

If anxiety sets in every time your share prices drop, this may be a symptom of overcommitment of your own cash into the particular shares. It stands to reason that Foolish investors should always invest with what he or she is comfortable with.

To combat this anxiety, don’t be afraid to use smaller position and slowly build up your allocation in a particular company. Multibaggers usually don’t happen within months, and may take years for the compounded returns to add up. So, if the company that you chose is destined to be a multibagger in the future, there will be plenty of time to add to it in the years ahead.

Foolish take away

The two simple steps above is what I have found to be useful to help Foolish investors invest fearlessly. Instead of fearing market corrections, I am excited when a correction happens as it usually means that I am able to pay cheaper prices for the best companies out there. As my US colleague, Morgan Housel notes:

“The funniest thing about markets is that all past crashes are viewed as an opportunity, but all current and future crashes are viewed as a risk”

Well, I know for sure that I would rather view market corrections as an opportunity rather than risk. How about you? Read more about investing and get more investing tips and tricks, FREE! Sign up here to The Motley Fool Singapore’s fearless weekly investing newsletter, Take Stock Singapore. 

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong doesn’t own shares in any companies mentioned.