Reacting to a market crash is easier said than done. That’s why it’s best to have your wallet prepared to withstand such a tumultuous situation before it actually happens.
The last decade has seen an environment of very low interest rates. This has dampened the returns investors can get from things like bonds and other fixed income. To maintain those returns, stocks were the only game in town. This fueled a market rush where stocks achieved very high rewards relative to actual earnings and relative to total equity.
It is foolish to try to say exactly when another market crash might occur. These are three steps everyone can take to be ready for when that day comes.
1. Store the dry powder
The best way to handle a market crash is to find a way to take advantage of it. Having cash on hand to buy opportunities that arise is the way to do this.
Learn from Warren Buffett. Buffett does some of his greatest comedies during the volatility. It can do this because it holds a lot of money ready for use. He often talks about how inflation eats up cash value, but Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) it tends to keep billions in cash on hand for when opportunities arise.
Cutting some investments that have made big gains is a way to lock in profits, while also putting some cash in hand to take advantage of a market crash. Conversely, it may be more tax-efficient to cut positions that have done poorly. Cutting your losses isn’t always a bad thing.
2. Manage the risk
Preparing for a market correction depends a lot on the quality of your portfolio. You can’t necessarily put everything aside while waiting for a recession; especially if you are invested for retirement. What you can do is make sure you invest in quality entities. Many of the best-performing names this year have been technology-related growth stocks. The market as a whole has been unbalanced in its run to all-time highs. Overexposure to equities based on growth momentum, or total balance sheet equity, could put your portfolio in trouble.
Look for the weak links in your wallet and remove them from the equation. Focus on safer actions that can help you.
3. Stay focused on the long term
Panic is everyone’s enemy. Just because your investments have gone down doesn’t mean they will stay low. If you’ve bought solid companies that are prepared for long-term business success, don’t worry about short-term turmoil. Those investors who oversold in the spring of 2020 are likely living with some regrets.
If you see some things that are directly related to the collapse, or a company that could face bankruptcy or irreversible damage, it may be necessary to abandon those investments. Similarly, the change in performance between stocks, fixed income, commodities, etc. It will require corresponding adjustments. These moves will be much easier if your portfolio has already been reviewed and your risk reduced. Overall, it’s important to stay calm and look forward to the long term.
Having some free liquidity and making sure your portfolio isn’t overly risky are important things to keep in mind when the market is this high. At the same time, it is important to keep the perspective. Long-term investors tend to do better when they don’t over-adapt to a short-term market swing. Over time, the market has only gone in one direction. Sudden volatility shocks can make investors forget this.