Reacting to a market crash is easier said than done. That is why it is better to prepare your portfolio to withstand a turbulent situation before it actually happens.
The last decade has seen a very low-interest-rate environment. The return that investors can get from things like bonds and other fixed income has been weakened. To keep those returns, equities are the only game in town. This fueled a market run in which stocks achieved very high premiums compared to actual earnings, and in comparison to total equity.
It is foolish to try to say exactly when another market crash may occur. Here are three steps everyone can take to prepare for that day.
1. Keep the powder dry
The best way to handle a market crash is to find a way to benefit from it. Having cash on hand to buy opportunities to present themselves is the way to do that.
Find out from Warren Buffett. Buffett does some of his biggest game play while upset. He can do this because he keeps enough cash ready to use. He often talks about how inflation eats up the value of cash, but Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) tends to keep billions of cash on hand for when the opportunity arises.
Cutting off some investments that have made big profits is one way to lock in profits, while also putting some money on hand to take advantage of a market crash. Conversely, it may be better to tax to cut positions that are not well done. Cutting off someone’s loss is not always a bad thing.
2. Manage risk
Preparing for a market correction is a lot about the quality of your portfolio. You can’t just completely set everything on the side waiting for a downturn; especially if you have invested for retirement. All you can do is make sure you invest in quality entities. Many of the best performing names this year have been tech-related growth stocks. The market as a whole has not been balanced in its haste all the time up. Excessive exposure to stocks based on growth momentum, or total equity balance, can set your portfolio for the disease.
Find the weak links in your portfolio, and remove them from the equation. Focus your attention on safer stocks that may carry you.
3. Keep focused on the long term
Panic is the enemy of all. Just because your investment goes down does not mean they will stay. If you buy good companies that are primed for long-term business success, do not worry about short-term turmoil. Investors who sell too much in the spring of 2020 can live with some regrets.
If you find some items directly related to the crash, or a company that may have suffered losses or irreversible damage, those investments may need to be discarded. Similarly, changing performance between equities, fixed income, commodities, etc. will require corresponding adjustments. Those transfers will be easier once your portfolio has been reviewed and your risk has been reduced. In general, it is important to keep your cool and look long lasting.
Having some free cash prepared and ensuring your portfolio is not overly risky are important things to keep in mind when the market is so high. At the same time, it is important to maintain perspective. Long-term investors tend to do better if they do not overly adjust to a short-term market swing. Over time, the market has only gone in one direction. The sudden shock of volatility can cause investors to forget that.