I’m not acting like a stock market crash is on the horizon. While there are compelling arguments for the market being overvalued, there are also compelling arguments that suggest more gains can be made for people who hold on for the ride.
Also Read How to Take Advantage of a Recession
However, it’s worth considering how you would respond to a market crash. A lack of preparation in this key area can result in you making considerable mistakes with your portfolio that can result in heavy losses.
My first test as an investor was 2018. That year ended with a big dip, and I was unprepared. I got anxious and sold some of my investments at their lows only to see them rebound. Although it was a correction rather than a market crash, it shows how unprepared I was in that moment.
If you’ve been part of a correction or a crash — whether it be a certain stock or the market at large — think of how you responded in that situation. Was your response
Will Stock Market Crash in 2021
Sometimes it makes sense to hold while at other times it makes sense to sell. If the growth catalysts remain and the company is unchanged by recent stock price movements, it makes sense to hold onto the company. If the company dramatically changes (i.e. credible fraud allegations that get proven), it makes more sense to sell that stock.
But in the event of a market crash, what can you do? Here are some ways to prepare…
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Review Your Portfolio
Are you confident with each investment in your portfolio? If your biggest winners were in the red instead, how would you feel about those stocks?
The more stocks you add to your portfolio, the easier it is for certain stocks to fall through the cracks and ultimately go unnoticed. I currently have almost 40 different stocks in my Fidelity brokerage account…more than I thought I had.
It’s easier for stocks to fall under the cracks now versus when I only had 10 stocks in my portfolio. You bought into certain stocks because you believed in those companies or you heard about them from a friend.
Do you still believe in those companies?
For some stocks, you can simply glance at the ticker and now that you still believe in the company. I glance at MGNI on my Fidelity brokerage account and know I’m holding onto that company for years to come.
There are other stocks in my portfolio such as CMBM, INOD, and CLS which are negligible parts of my portfolio (I haven’t invested more than $25 into any of those companies).
I saw something good in those companies to add some shares to my portfolio (or just a single share), but I have to review those individual stocks again to decide if I want to build up those positions.
Know where you stand with each of your positions now so you don’t suddenly view them in a negative light in the event of a correction or crash.
Buy Short-term puts
Puts allow you to benefit from the downward motion of a stock’s price. Short-term puts allow you to avoid panic selling because you lock your losses. In the event the stock goes up, the put will expire worthless, but you’ll get the appreciation from your existing shares.
However, if the stock price goes down, the put will cushion the blow. The best success I’ve ever had with a put was with Fastly. The stock had a massive run-up and looked overvalued to me. I bought a put and the stock proceeded to dip more than 255 in the after hours.
I don’t recommend becoming put happy. I was impressed with my luck and decided to swap this put in for two out of the money Fastly puts. I lost some money with those but ended up keeping my shares and ended with a gain from the put positions.
As of writing, Fastly trades for a little over $110/share and should eventually return to its all-time high. I’m very happy I didn’t panic sell my shares. Buying the put allowed me to be more confident in the stock knowing my downside was limited.
Shift To Undervalued Dividend Stocks
In a stock market crash, the overvalued stocks get hit the hardest. The undervalued stocks don’t have as far to fall from a valuations standpoint.
While my portfolio is primarily filled with growth stocks, my portfolio includes undevalued dividend stocks such as Prudential. I wouldn’t suggest selling growth stocks to shift into undervalued dividend stocks as you’ll have to pay the capital gains for those sales.
You can focus on undervalued dividend stocks with your future monthly contributions if you want to better protect yourself from a crash.
Dividend stocks benefit from a crash because the dividend reinvestments net you with additional shares since the stock price is deflated. The crash only becomes an issue for dividend stocks if the companies are forced to reduce or suspend their dividend. Buying solid companies with low payout ratios (anything under 70%) reduces the likelihood of that scenario.
Weather The Storm If You Can
For most investors, the best approach is to do nothing. This too shall pass. The market will eventually rebound and return to its pre-crash levels. The losses may be painful in the moment but solid companies will find ways to rebound and continue growing.
The only concern at this point is your immediate expenses. Can you truly weather the storm, or will you be forced to sell your investments to cover your living expenses?
If you have to sell your investments to cover expenses, consider a dividend portfolio. Rather than having to sell your stocks, use the dividend payments to cover your expenses instead. This becomes more realistic on a full-time level if you are sitting on a big nest egg, but you have to start from somewhere.
Being forced to sell your investments to cover your expenses can result in you selling incredible companies at inconvenient price points.
If you’ll need the money within the next 3–6 months, it shouldn’t be in growth stocks. You should instead pick safer investments for that money such as a CD or a money market.
Also Read How to Take Advantage of a Recession
Focus On Growing Your Income
Also Read 7 Common Money Traps to Avoid
When a portfolio bleeds red, it’s not exciting. It’s hard to look at some of your hard earned money suddenly vanish. That’s part of the game with any investment. Somedays you’ll magically get more money. On other days, some of your hard earned money will suddenly vanish.
It’s easy to focus on our portfolios, but a key determinant in our wealth is how much money we contribute to our portfolios each month.
Earn from Stock Market Crash 2021
The more you make and the less you spend, the more you can contribute to your portfolio each month. Growing your income allows you to grow your portfolio and do a better job at paying off expenses.
The latter is just as important because then you won’t have to sell your shares to pay your living expenses.
Even when you leave your job, you should never fully retire. I’m an advocate for the semi-retirement lifestyle where you still work part-time but on your terms.
You should always place a strong emphasis on income growth. That will help you with portfolio growth and make a downturn in the stock market less stressful.