But panics have a way of short-circuiting the market's best-planned defenses. Peter Schiff, president of Euro Pacific Capital, offers one scenario with the power to prompt a meltdown: "If we wake up one morning and learn that: Overnight, the value of the dollar has plunged 15% to 20%; prices of U.S. Treasury bonds have plummeted, pushing yields up 3 or 4 percentage points; and commodities, such as gold and oil, skyrocket." In essence, he says, investors should fear anything that indicates a serious movement away from dollar-denominated assets, or something big that would change the investment equation in a matter of hours — such as news hinting at a serious recession.
A geopolitical crisis, forced selling by overleveraged investors or a meltdown in Wall Street-created products, such as derivatives, could also cause a panic.
Still, a 22.6% drop today is unlikely to occur in a single day, says Schiff. "Maybe the Dow goes down 1,000 points per day for a week. Boom. Boom. Boom."
One thing is clear: You can't plan a portfolio around a megacrash. "Could it happen? Sure. Should I bet my portfolio on such a rare event? No," says Liz Ann Sonders, chief investment strategist at Charles Schwab. Most crashes occur after excesses. So don't be greedy. Scour your portfolio for big winners, be it in Chinese stocks, oil or emerging markets, and trim those positions before markets tank, she says. Also, the 1987 crash turned out to be a great buying opportunity. Says Sonders: "After the calamity, start to add, add, add."
Waggoner reported from McLean, Va.; Shell from New York