How to proactively prepare for the potential crash of the stock market?
Preparing for a potential crash can do no harm. Creating an action plan to protect yourself from any losses would not only relieve you from psychological anxiety, but it would also keep your financial interests protected. Here are a few things that you can do in case the stock market crashed in 2021.
Do not panic
The first thing that you need to do is prevent yourself from panicking. Many investors make the mistake of taking stress-induced initiatives, which ultimately cause more harm than good. If you act impulsively, there is a very strong chance that you will lose money during this period. It is crucial to remember that stock market crashes take place for a limited duration of time. Therefore, it is important to stay calm and avoid making any rash financial decision as this is how stock market works around the world.
Consider the bear market incident that took place in March of 2020. While the stocks lost a good thirty per cent of their value due to the pandemic, the rates experienced a surge back towards the end of the year. As a result, it is imperative to not worry about the crash, as just a few months will be needed for the market to regain its momentum.
Avoid selling any investment unless it is necessary
As stated earlier, you would only lose money in the stock market if your investments. This is because if you decide to sell your stocks, the income generated would be less than the price at which they were purchased. Hence, you would experience a loss. Taking that into account, it is crucial to avoid liquidating any financial asset, unless it becomes absolutely necessary.
Instead, start contributing to your emergency fund to make sure that you do not find a reason to sell your stocks.
Acquire new stocks with your excess savings
Stock market crashes have a negative impact on the overall economy. However, as an individual investor, you can benefit from the decline in the market by acquiring new stocks at a reduced price. To prepare for this, you can open up a savings account to collect enough money to buy new stocks at an affordable price.
You can also spend time and do your research to create a list of stocks that you would be interested in buying. This would give you an idea of an approximate amount of money that you need to save in order to buy the stocks that you have your eye on.
With that said, do not start a savings account at the expense of your emergency fund. The emergency fund can protect your financial interests in the unfortunate case of unemployment.
Place your money in high-growth stocks
Despite the chaos struck by the global pandemic on the stock market, there were several high-growth stocks that failed to take the hit. For instance, tech companies worked against the odds and still yielded a significant profit. Keeping that in mind, you can carry out a little bit of research to ensure that the new stocks you acquire are high-growth. This is because high growth stocks tend to recover more quickly after a crash. Therefore, adding these to your portfolio can be advantageous.
Acquire income-generating stocks
Keeping a diverse portfolio is always recommended. If you only have high-growth stocks in your portfolio, its condition would be quite volatile. Therefore, adding a few income-generating stocks can not only diversify the portfolio, but it can also relieve you of additional stress. It is not important to get high returns with these stocks, rather, the reason for this investment would be to have some reassurance in case the stock market does experience a crash.
Invest in a business
Essentially, investing in a business, during a market crash, can be financially reassuring. However, it is recommended to do thorough research on the business you wish to invest in, as the uncertainty of the pandemic can lead to more losses if a rash decision is taken. Choosing a tech company can be ideal, as its operations would not be hindered as much by the restrictions of the pandemic.
It is troubling to imagine another stock market crash, however, there is no guarantee that it will happen. Although it would be expedient to stay ahead of the crisis, in the case it does occur.
Common mistakes that investors make and how to avoid them
The smallest mistakes during a crash can cost you a lot. Therefore, it is important to avoid the common mistakes that all investors tend to make during a crash in the market.
Surviving a stock market crash does not depend on the nature or number of investments you own. Rather, what you think about your investment portfolio and how you react to the market crashing can determine the next course of your finances.
Traditionally, investors attribute portfolio risk to asset allocation. This means that if you do not work well with risks, it is recommended to step away from stocks and place your money in bonds and cash opportunities. On the other hand, if you are not concerned about the risks, and wish to take a more daring approach, asset allocation in the direction of stocks can work out in your favour.
If you wish to discover the right approach to asset allocation, you can take a risk tolerance questionnaire. A risk tolerance questionnaire is a document that allows you to gain an insight into what you would naturally do in a market crash. However, these questions are quite theoretical, therefore, your answers may not reflect your actual response to a realistic situation.
With that said, the document can provide you with a sense of what the asset allocation, in terms of stocks, bonds and cash, is recommended. However, you can expect gaps in information, such as what stocks you need to buy or sell, as well as the ways in which you can manage larger concentrations in individual stocks.
Create an equilibrium
If you have already invested in index mutual funds and ETFs, it is recommended to take on the traditional rebalancing approach. Conversely, if your stocks have performed relatively better than the other segments of your portfolio, in such a case, you can sell a small share of your stock holdings and allocate it to bonds, cash or any other class of assets. The key is finding a balance to what you are comfortable with, in an unexpected case of a crash.
However, if you are an investor with individual stocks, you would need to consider additional factors, such as the following.
- If you have invested in high-growth stocks that may experience a pullback in a crash, it is recommended to reduce your concentration in high-growth stocks and replace it with stocks demonstrating an encouraging investment.
- If you have possession of value stocks that have lost ground during the pandemic, consider how they will perform in a potential crash. If the result is not promising, allocate your finances towards a more valuable asset.
- In the case you have possession of winning stocks, it is recommended to hold on to them for a while before selling. Selling a winning stock at a swift pace can be a mistake. However, if an isolated stock contributes to more than fifty per cent of your total possessions, you can trim off of it a little to purchase a share of high-potential companies.