Every investor needs to be ready for the next downturn. Here's how.
The stock market has been on a pretty good streak this year. Sure, there were some rocky weeks, but all told, 2021 has been a strong year for stocks.
But when it comes to investing, good things tend to come to an end, at least for a period of time. And that's why it's important to gear up for a stock market crash.
It's impossible to predict when the stock market will take a turn for the worse. Right now, stocks are inflated across the board, and many stock prices don't reflect the actual value of the companies behind them. And when you have a situation where many stocks are trading for more money than they're actually worth, it sets the stage for everything to come crashing down.
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Of course, we may not see a full-fledged stock market crash this year. We may not even experience one next year. But if history tells us anything, it's that stocks will crash eventually. And here's what you can do to be ready.
1. Make sure you have a diverse portfolio
Your goal in buying stocks is to assemble a healthy mix that's likely to gain value over time. But you should also aim for a diverse collection of stocks.
Sometimes, stock market crashes can hit one segment of the market harder than others. So if you own too many similar stocks, your portfolio value could really take a serious beating.
Take a look at the stocks you have in your brokerage account. If you own 12 different stocks, but seven of them are tech stocks and four are energy stocks, you may want to swap a few of those for companies in other industries.
Another option is to buy exchange-traded funds (ETFs), which allow you to own a bucket of stocks with a single investment and are a great diversification tool. Many brokerage accounts let you buy ETFs and won't charge commissions to add them to your portfolio.
2. Make sure your investments are appropriate for your age
Many people invest money during their working years so they can use their portfolios as an income source during retirement. For this reason, it's important to not invest too heavily in stocks if retirement is right around the corner. In that situation, you're better off trading in some of your stocks for bonds, since their value is less likely to fluctuate for the worse, even during periods of turbulence.
But if you're in your 20s or 30s, there's no need to dump any of your stocks or swap them for bonds, even though they've historically been less volatile. The reason? Even though stock market crashes can cause portfolio values to sink, if you're fairly young, you have plenty of time to sit back and wait for the market to recover. And to be clear, the stock market has managed to recover from every downturn it's experienced.
3. Make sure your emergency fund is solid
One of the best things to do with your brokerage account during a stock market crash is nothing at all.
When stock values fall, your portfolio value is apt to follow suit. But what you're looking at is something called a loss on paper (or, in most cases today, a loss on screen). So try not to panic or let it get to you. You won't be looking at an actual loss until you sell off stocks at a price that's lower than what you bought them for. And that's also why not touching your brokerage account is one of the best ways to handle a stock market crash.
That said, sometimes, emergency situations strike and the need for cash pops up. If you find yourself in a position where you need to sell off some stocks to drum up funds, you could end up taking losses during a market crash. On the other hand, if you have a fully-loaded emergency fund, you'll be able to use that as a cash source and leave your portfolio alone when the market is doing poorly.
A stock market crash is coming at some point. When exactly, we don't know. But if you employ these tactics, you can set yourself up to breeze through the next one.
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