Thursday, May 19 2022

Stocks are under pressure from inflation fears, and that can make you worried about an impending crash. Unfortunately, there is no protective helmet for investors available to protect you from turbulent markets. But there are other ways to prepare for the difficult times ahead.

To be clear, I’m not predicting the market will crash this month or this year. I can freely admit that I am bad at forecasting the market. For this reason, I am sharing four crash preparedness strategies that don’t involve selling, taking short positions, or doing anything that backfires on you if a crash doesn’t happen.

1. Check your cash reserve

A stock market crash stings the most when you need to liquidate. Selling an asset at a loss is universally unpleasant. And the sentiment is compounded if the market rebounds quickly and you are not positioned to profit from it.

Image source: Getty Images.

A healthy cash reserve is your first line of defense. If the market collapses and you lose your job the next day, hopefully your money can keep you afloat until you replace your income. At a minimum, liquidity will reduce your reliance on liquidation and give you time to participate in the market rally.

Experts recommend having enough money to cover three months or more of living expenses. If you don’t have that amount today, you have some tough choices to make. You can liquidate part of your portfolio now, knowing that you could miss out on any gains if investors get bullish. You could sell a different asset. Or you can temporarily cut your living expenses to the essentials and save in your fund.

2. Review your speculative positions

Small caps and speculative games in your portfolio are often the hardest hit in a crash. Part of this is the result of investor perceptions. When the market gets risky, many investors will abandon their speculative positions and turn to trusted defensive names like Procter & Gamble (NYSE: PG) or Mcdonalds (NYSE: MCD). This trend naturally puts downward pressure on small company stocks.

Investors are making this shift because small businesses tend to have a harder time in tough business climates. They may not have the leadership experience and do not have access to the capital they need to seamlessly manage declining income or increasing expenses.

Review your portfolio and identify the positions that present the most risk in a downturn. If they collectively represent more than 5% of your portfolio, consider reducing your exposure.

3. Rebalance

the S&P 500 (SNPINDEX: ^ GSPC) has increased by over 41% in the past 12 months. If you haven’t rebalanced your portfolio lately, you are probably overweight equities. This is not where you want to head into an uncertain market.

You should also re-evaluate your investment plan at this point. Rebalancing to an asset allocation that reflects your outlook from five years ago is not very helpful. You are older and perhaps more risk averse now than you were even a year ago. Redefine your target asset mix based on your current situation and then rebalance it accordingly.

4. Look for an opportunity

A stock market crash creates the opportunity to buy good stocks at lower prices. For this reason, your preparation plan should include offensive and defensive moves. Start looking for stocks you would like to buy in a crash and make your wishlist.

You will likely find that focusing on the opportunity is an emotional game changer. Instead of anxiously waiting for your assets to drop in value, you can anticipate your portfolio strength on the other side. You might even feel a hint of disappointment if the market finds its balance and returns to growth.

Ready for everything

The market sometimes crashes and there is no headgear to protect you. Accepting these facts as inevitable is a big step forward in preparing yourself for whatever will happen next. If you are also impatient to act, add to your checkout stores, then review and rebalance your portfolio.

You can also put some energy into window shopping for stocks. That way, in the event of a crash, you’ll be ready to enjoy it.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.


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