We’re not attempting to predict the next market downturn, and certainly not a market crash. But it is certain that a downturn of some sort will happen in the future. It’s always best to have at least a loose plan in place to protect yourself and your investments from such an event.
These strategies will help to minimize the damage both to your investment portfolio and to yourself on a personal finance level.
Here’s what you can do to protect yourself and your investments from a market downturn.
Make Adjustments Before the Market Heads South
When it comes to a stock market downturn and especially what might eventually turn into an outright crash, the best strategy is always advanced preparation. If your portfolio has done well, you may want to take some profits while we’re still at the top of the market. You may also want to move some money into high-dividend paying stocks and also investigate real estate investment trusts in order to stabilize your investment cash flow.
Taking action before a market downturn provides you with many more options than you will have once the decline begins in earnest.
Sell Stocks That Weren’t Doing Well
If a stock did not do well during the bull market, it could very well get clobbered in a bear market. Though you don’t want to begin selling off your stock portfolio wholesale, you should look to get rid of any laggards. Not only will this minimize the losses you take in your stock portfolio, but it will also help to raise cash so you will be in a better position to buy new stocks after the market bottoms out and stabilizes.
Don’t Do Anything Drastic With Your Portfolio
If the market is already clearly heading south, you should want to avoid taking drastic action. This includes selling off your stock positions. Selling into a decline locks in your losses permanently. And if the stocks you’re selling are fundamentally strong, there’s no reason to sell anyway.
Sooner or later, they will come back, and you will be better off holding onto them than trying to properly time both the sale and eventual repurchase of the same stocks.
Another complication with taking drastic action in an existing bear market is that you have no way of knowing what the duration or severity of the downturn will be. If it’s a short, sharp selloff — similar to the crash of 1987 — liquidating your positions into the decline will be completely counterproductive. And if it’s a long, slow downturn, stocks you own that are strong may very well resist the trend, at least to some degree.
Stop Buying New Stocks Until the Market Stabilizes
Just as you don’t want to be selling off large blocks of stock into a decline, you probably don’t want to be buying any either. If you do, you can get caught in the catch a falling knife trap. That’s when you buy a stock at what you think is a bargain price, only to watch it continue falling even lower, sometimes much lower.
Stocks should never be purchased during times when the market is making radical moves, whether up or down. That’s because the major movements in the general market tend to distort individual stock prices.
The best time to buy stocks is when things are calm. That might mean waiting until after the general market has taken a big hit and seems to be settling into a trough where it may be building momentum for an eventual move forward. And at that point, there’ll be plenty of stocks selling at massive discounts. These will represent the very best stocks from an investment standpoint.
So far we’ve talked about strategies to protect your investments. The remaining strategies will center on protecting yourself and your family from a major market downturn. Since major downturns are often the result of economic turmoil, you will need to do whatever you can to improve your personal financial situation to be prepared for whatever may happen.
Work to Become the Best Employee
It’s an unfortunate reality that major market downturns are usually accompanied by significant weakness in employment. This means not only will your investment portfolio be vulnerable in a crash, but your job may be also. Companies rely on capital provided by the stock market, and when that dries up, operations and future plans can be cut. Jobs will disappear with those cuts.
For that reason, you need to work to become the best employee in your department or company. Poor performers will usually be the first employees eliminated in a decline. If you can position yourself as one of the best, you may insulate yourself from a layoff.
Accumulate a Cushion of Cash
If there is one money move that has the most beneficial impact during a major market decline, it is accumulating cash.
There are two purposes for doing this:
Survival cash. You will need to increase the amount of cash you have for survival. If you have three months’ living expenses sitting in your emergency fund, plan to increase it to six months. If you have six months, plan to increase it to a full year. This will not only provide you with cash to live on, but it will also cut down on the need to liquidate your investment portfolio for survival purposes.
Investment cash. No matter how well positioned your portfolio is, if the market decline is strong enough, you will lose money. The best workaround is to build up cash so you will have liquidity to buy stocks at the bottom of the market. If you can, the additional stocks — plus your original holdings — will increase your investment profits when the market begins its next upswing.
Cut Your Living Expenses
A major market downturn is an excellent time to lower your living expenses. Any product or service you don’t absolutely need can be eliminated, along with the monthly expense of maintaining it. The reduction in expenses will not only improve your budget but will also provide you with additional cash for savings.
Delay Major Purchases
If you are planning on buying a brand-new car, it may be best to delay doing so until the market stabilizes and you have a chance to assess the economic damage it caused. Though there may be official denials that what’s happening in the stock market will have any tangible effect on the economy, the negative impact will expand the deeper the market decline goes. For this reason, you should hesitate to take on any new expenses.
Rather than buying the new car, hold on to your old car for another year or two — especially if you own it free and clear. The last thing you want to have happen is to add a $500-per-month car payment to your budget and then lose your job six months later.
Pay Down Your Debts
Though accumulating cash should be the priority, you should consider paying down or paying off debts if you’re comfortable with the level of cash you have. Probably the best debt to pay off will be a car loan. By paying it off, not only will you be eliminating a major monthly expense, but you’ll also be taking your car out of harm’s way. Lenders can’t repossess a car that doesn’t have a lien on it.
You might also consider paying off small credit balances or paying down larger ones. The reduction in monthly payments will help to improve your cash flow.
Paying down your mortgage is problematic in a stock market crash. This is because you will be committing cash to the reduction — but not the payoff — of a very long-term debt. One of the unfortunate realities with a mortgage is that no matter how much of the principal you pay off on the loan, the monthly payment will remain the same.
Having the cash at your disposal will probably be more valuable to you, from both a survival and an investment standpoint, than lowering your mortgage balance.
Probably the worst strategy in dealing with a market downturn is doing nothing. For better or worse, the U.S. economy — and even the global economy — are tied to the financial markets. A major decline in stocks will translate into at least some level of economic misery across the board. Having a strategy plan in place to deal with it will be your best defense.
Readers: How do you deal with a market downturn? What’s one thing you do to protect your investments?