How to Prepare for a Stock Market Drop: Investing Strategies & Tips for Market Crashes

When there's a stock market drop, what do Rule #1 investors do?

Stock market trends create fluctuations. The market goes from an emotional status of exuberance and excitement with an overheated market environment, to the exact opposite. The opposite emotion is fear, everything is horrible, everybody's unemployed, and the sun is never going to come up tomorrow. That's a stock market crash.

During a market crash, fear dominates—people imagine worst-case scenarios, believing everything is horrible and the economy will never recover. But smart Rule #1 investors see these moments as opportunities.

Stock Market Trends: Warren Buffett and Coca-Cola

Stock crashes can provide unique opportunities. Here's an example from Buffett's portfolio...

Warren Buffett had about 10% ownership in Coca-Cola in the late 1990s when its stock became excessively overpriced and subsequently crashed by 50%. Despite recognizing the overpriced situation, Buffett didn't sell—not due to principle but because his substantial position limited his agility. He was asked in one of his meetings why he didn't sell it. Buffett basically said, "Well, because I'm not nimble. Not because you shouldn't sell it."

He would have crashed the stock all by himself if he sold it. He didn't respond the way a lot of people thought he would if you "never sell."

He didn't say, "We would never sell." He said, "We didn't get out, even though we knew it was over, because we couldn't."

But, you and I can. Individual investors have the advantage of flexibility and can swiftly react to market changes.

Let's start with a couple of basics that are fundamental to Rule #1 Investing and learn the 4Ms to Rule #1 investing by clicking here.

What should you do to prepare for a market drop? Here are the basic things you should be doing.

1) Be Patient in Cash: How to Prepare for the Next Market Crash

Rule #1 investing requires patience. Legendary investor Charlie Munger puts it perfectly:

“You don't make money when you buy, and you don't make money when you sell. You make money while you wait.”

You can't do the kind of investing I do and that I want you to learn how to do, unless you're okay with sitting in cash. You need to be able to be patient.

Sitting in cash means keeping money in your money market account, or in short term bonds. Something where you can get your hands on it when you need to.

You have to be willing to do that for a period of time while you're waiting for these fluctuations in the stock market to come along.

This is where the average person can jump over 6-inch bars, because the market is going to give you those 6-inch jumps once every 5 or 6 or 7 years. Sometimes it happens more often.

2) Be Ready to Load Up When it Happens

Prepare yourself by researching and identifying wonderful companies before the crash. When the market falls and these stocks go on sale, you're ready to act. I recommend buying in stages:

• Purchase 25% of your intended investment when prices first drop into your target range.

• If prices continue falling, add another 25%, repeating this process as prices decrease.

• Once you confirm the market has bottomed out and begins recovering, invest the final 25%.

3) Be Ready to Exit When Markets Reach Extremes

Recognize when markets become irrationally high, signaling it might be time to exit positions. Evaluate stocks you already hold:

• If the company's price aligns with its intrinsic value, investors must evaluate whether holding onto it makes sense.

• Retain stocks that remain undervalued, positioning yourself to buy more during future drops.

4) Manage Your Emotions and Invest with Conviction

Successful investing requires emotional discipline. Avoid letting fear or greed drive your decisions. As I like to emphasize:

“Be sure you go outside when it's raining gold with a bucket, not a thimble.”

It's emotionally challenging to see prices fall and still confidently invest. If fear becomes contagious, it may prevent you from buying adequately. Instead of hesitating or making small, timid investments during market crashes, confidently seize opportunities by investing meaningfully when great companies become available at deep discounts. Staying disciplined ensures you capitalize fully on these rare opportunities.

Prepare Now for the Next Market Drop

Use your waiting period to thoroughly research wonderful companies. Then, when the market drops, you'll have conviction and clarity and you will be ready to move with confidence.