Investors must frequently react to events that could affect the stock market’s outlook. For example, they may be forced to re-evaluate their view of a specific stock or sector based on factors such as rising inflation or increasing interest rates. Similarly, a rapidly rising, or falling, stock market may mean they need to change how their capital is apportioned.
Of course, such events are impossible to predict before they take place. This means that even if investors try to forecast how the economic outlook will evolve or how the stock market will perform in the future, they will still need to react to real-world events. Indeed, as former Magellan fund manager Peter Lynch once stated, events are only obvious after they have occurred: “Remember, things are never clear until it’s too late.”
Making sound plans
However, this does not mean that investors should solely focus on reacting to events. In my view, planning for a variety of possible outcomes is a logical approach to investing that could mean an investor is in a stronger position to react to them.
For example, investors do not know when the current bull market will end. But history suggests this event will occur at some point in the future, since no bull run has lasted in perpetuity. As such, it could be prudent to position a portfolio so that it continues to benefit from further stock market gains but can also capitalize on any future downturn. This may be achieved by holding a large proportion of assets in stocks but also allowing a cash balance to gradually rise so an investor can take advantage of lower valuations in future.
Similarly, businesses with weak financial positions, such as through having large amounts of debt, were among the hardest hit during the March 2020 stock market crash. Following that, they have been among the strongest recovery plays in the current bull run due to an improving economic outlook and lower interest rates. Avoiding such companies in favor of fundamentally sound businesses could be a simple but effective means of planning for the next economic downturn.
A long-term focus
Clearly, plans that include increasing a portfolio’s cash balance and avoiding relatively risky stocks could fail to pay off in the short run. They may lead to disappointing returns should the current bull market continue. Buoyant investor sentiment may naturally increase demand for, and the share prices of relatively risky stocks. Meanwhile, low interest rates could mean investors holding rising cash balances become frustrated.
However, planning for a range of future events could mean an investor is better placed to overcome them. They may also be in a stronger position to successfully react to them. This does not mean they should seek to predict how the economy or stock market will perform in the future. But by accepting that unforeseen events will always occur that prompt different investing conditions to those previously anticipated, they may be able to apportion their capital more efficiently over the long run.
