Concerns regarding one’s financial situation are shared by all. It’s natural to feel anxious about a potential financial crisis if you don’t have much money saved. It’s true that having financial security can ease anxiety, but it doesn’t eliminate it. In the event of a stock market crash, where our money is invested, this becomes especially true. Most investors weren’t prepared for the massive drop in the stock market that occurred in 2020 during the first wave of the COVID-19 pandemic.
Though it’s hard to know when a market will crash or correct, there are steps investors may take to protect their portfolios from the effects of such events.
In this post, we’ll go over seven methods that traders can use to protect their portfolios from the negative effects of a stock market meltdown.
How to Respond to a Stock Market Crash
In the event of a stock market meltdown, here are some steps you can take.
Stick to Your Investing Plan
A good investment plan isn’t simply something you utilize when the market is going up; it’s also something that keeps you safe when the bears take over. When stock prices begin to drop, you shouldn’t have to give up on your plan.
Instead, stick with your plan and let the countermeasures it contains take effect.
On the other hand, you might find it necessary to make a few alterations to the asset allocation strategy you’ve developed. This is especially true if the stocks in your portfolio tend to move in cyclical patterns. You might want to adopt a more pessimistic outlook by boosting your allocation to safe havens and rebalancing your stock holdings to include a greater number of non-cyclical sectors like healthcare and utilities.
Avoid Panic Selling
Many people, especially inexperienced traders, react to market declines by selling all they own out of fear. Those who have experience investing for the long run understand that panicking is not the solution.
You might want to sell certain stocks here and there, but you don’t want to liquidate your entire portfolio. Instead, you should evaluate your progress and make well-informed judgments about how to rebalance your portfolio as market changes highlight both favorable and unfavorable investment opportunities.
Consider Long Term
Crashing and correcting markets are nothing new. Many experienced long-term investors pay no mind to their short-term impacts since they occur so frequently. No matter what kind of investment you’re making for the long haul, there will be good days and terrible days. Poor choices are frequently made when people act hastily in response to current events.
Rebalance Your Portfolio
When you were putting together your financial portfolio, you made sure to strike a good balance. You gave some serious thought to your level of comfort with uncertainty and adjusted your asset portfolio accordingly. Certain investments expand at a quicker rate than others, and likewise, some securities decline at a quicker rate than others during market downturns.
After a market crash, your investment portfolio is probably not as well diversified as it was before the decline.
It’s important to reevaluate your comfort level with risk whenever you rebalance your portfolio. You might not be feeling as bold as you previously did, given the state of the market. The age you are at the time of investing might help you determine your level of risk tolerance and the appropriate asset allocation for your portfolio.
If you’re 45 years old, it can make sense to allocate 45% of your portfolio to fixed-income securities while keeping the remaining 55% invested in stocks. Obviously, this is merely a rule of thumb based on a standard level of tolerance for taking risks. Consider increasing your bond allocation if you wish to maintain a conservative portfolio till the crisis has passed. Consider increasing the percentage of your portfolio that is invested in stocks if you are more interested in taking a risky strategy when the market is falling.
Consider Harvesting Tax Losses
A tax-loss harvesting technique might help you save money on your investment taxes. Investing profits are taxed only at the end of the year. This is to say, you can utilize your losses to partially or fully offset your gains, and a market collapse is an ideal opportunity to do this.
It’s also wise to wait until a stock has stabilized before selling it off entirely merely because it’s losing money. A stock bought three months before a market crash would not have had much time to become profitable before the downturn. It may, however, be declining at a slower rate than other holdings in your portfolio and thus be worthwhile to keep.
If you need to decrease your tax liability, you shouldn’t just sell your shares at random; instead, you should seek ways to take advantage of the stock’s poor long-term performance.
Take Advantage of Investment Opportunities
Market corrections and collapses are seen as opportunities by smart money investors, such as billionaires George Soros and Warren Buffett. Warren Buffett advised investors in 1996: “Be frightened when others are greedy, and greedy when others are frightened.”
Even though it was said more than twenty years ago, that saying is as relevant now as it was then. If the big shots on Wall Street see crashes as opportunities, you should too.
- Buy the Dip
When the market is down, Warren Buffett typically spends billions buying up shares of firms. This is a clever and financially rewarding strategy. Now that panic is spreading on Wall Street, he hopes to buy low.
Buffett is well aware of the fact that any substantial drop in the market is quickly followed by a bull market. You can also benefit from the bull market recovery if you do your homework before investing and look for inexpensive quality stocks.
- Buy Index Funds
You can buy the dip in the market as a whole if you’re not confident in buying individual shares during a market crash. While it’s true that individual stocks may never be the same, the market as a whole has a history of making comebacks.
Index funds and other broad-exposure ETFs and mutual funds are your best bet for getting a complete picture of the market. These funds are a low-cost option to invest in pools of hundreds or thousands of stocks all at once, and they were designed with diversification in mind.
- Keep An Eye on Mergers and Acquisitions
During market downturns, when investors are nervous, established firms may afford to buy upstarts at steep discounts. Furthermore, during a market downturn, the willingness to spend hundreds of millions or even billions to acquire another company is indicative of a stable financial position.
Companies in this industry are often undervalued because a fearful market fails to account for the value added by acquisitions. When economic conditions improve again, these companies will be better off than before.
- Dollar-Cost Averaging
There is no reliable method for predicting when the market will peak or bottom. You don’t want to miss the finest days by waiting for a rebound, and you also don’t want to miss out on profits by buying too high.
What you need to do is dollar-cost-average your way to success. Spreading your investments out over time and making equal purchases of a stock on a consistent basis will help you avoid buying at the peak or missing out on the subsequent bounce.
Prepare Yourself for the Next Stock Market Crash
There have been market declines before, and it’s likely that there will be others in the future as well. Next time, you won’t have to be taken aback. You can get ready in a few different ways.
- Diversify Your Portfolio
It’s important to diversify your holdings to preserve your portfolio’s worth, no matter how boldly you enter the market. You can minimize the impact of a regional economic slowdown by diversifying your stock portfolio with domestic and overseas stocks. With a balanced portfolio of cyclical and noncyclical stocks, you may cushion the shock of a local or global market slump with your noncyclical holdings.
In addition to that, you can take the concept of diversification even further. Think about buying something of value to use as a hedge against inflation, like a piece of art, a piece of real estate, or precious metals. Investment options are not limited to the stock market.
- Maintain Balance
Your portfolio needs to be rebalanced often, not just after a major market decline. You should adjust an ETF-based passive portfolio at least twice a year, and more frequent rebalancing, such as quarterly or monthly, is perfectly acceptable.
More frequent rebalancing is necessary for an active portfolio that includes both stocks and fixed-income instruments. Rebalancing should be done at least once every three months, but monthly may yield better results.
Regardless of the strategy you choose, you can be assured that your portfolio will shield you from irrecoverable losses in the event of a market crisis as long as you keep it consistently balanced.
Stock market crashes are frequent. Both fear and greed drive market activity. When feelings are involved, reactions become more intense in almost every circumstance. In the market, it’s the same.
There is no reason to be concerned about a market crash. Even though they’re not much fun when you’re in the midst of a 30% decline from your peak, market downturns offer advantages unavailable during any other phase.
Consider how excited you would be if you walked into your go-to shop and saw a sign advertising 30% off everything. In the eyes of a skilled investor, a market collapse is just a massive version of the same thing.
The secret is to keep a cool head and do your research before making any investment decisions. If you can manage that, you should be alright.