Can Americans Survive a Stock Market Crash?

It’s essential to consider how best to protect ourselves, our families, our homes, and our environment during these uncertain times. Whether you’re in the upper 1% or the bottom half, it’s likely everyone has investment portfolios of some sort. That might mean your retirement plans (401(k) or individual IRAs). Or it could be something much more significant than that. The size of your portfolio doesn’t matter for this discussion.

So, how do we protect our investment portfolio in light of the recent market downturns? What, if any, steps can we take to cushion the blows without sacrificing returns?

Today, I want to offer you five simple things you can do to protect your investment portfolio during these volatile times.

Protect Your Investment Portfolio

1. Have a Plan

If you’re investing isn’t done with some plan, it will be next to impossible for you to succeed. The plan guides everything else we’ll be discussing in the following sections. Your plan guides your investment decisions. You have to have a purpose behind the portfolio.

There are several ways to look at planning. For me, it starts with the question, “What do you want your investments to do for you?” Is it to fund or supplement your retirement income? Is it to save money to pay for your kids’ college education? Is it to save money for a large purchase? Whatever your answers to these questions, those answers should guide how you invest your money.

Investing for retirement is different from investing (saving) for a downpayment for a house. Retirement investing will have a longer time horizon than saving for a downpayment for the home. Because of that long period, when investing for retirement, you can take on more risk in your portfolio than for shorter periods. How much risk? We’ll dive into that in more detail in the next section.

Here is the main point of having a plan. It provides a roadmap. It has a target date (or time) when you want to use the money. That time will guide how you invest. It will keep you focused on the goal and not what’s going in in the short term. Volatility is part of investing in securities. There’s no way around it. In the previous ten-plus years, we had a great run in the market.

I’m assuming for this post that you have a plan. If you don’t have a plan underlying why you’re investing, it will be complicated for you to get through these kinds of times. Build that foundation first. Then proceed to the next steps.

2. Check Your Risk Level

Many investors, especially those who are just starting, have too much risk in their investments. I’ve heard many of them say something to the effect of, “Hey, I’m young. I’m in it for the long term. When it drops, I’ll buy more.” And that’s a great strategy – until it isn’t.

If you manage your investments, one or more of your mutual fund companies likely have portfolio analysis tools you can use. No one likes volatility when investing. Therefore, if the dislike turns into fear, it’s time to make changes. Make those changes sooner rather than later. If you’re looking for a diversified national portfolio, check out VOO vs SPY. When you’re looking to diversify your portfolio to international stocks, see if VTSMX or VTSAX fit your needs.

Changing your investment strategy doesn’t mean you should sell all of your stocks. That would not be prudent. What it does mean is to reduce the amount of money invested in stocks. How much? A good measuring stick would be to see how the portfolio would have performed in the crisis of 2008. As a result, when you look at that drop in dollar value, you get a sick feeling (the stomach test), lower your risk until that queasy feeling goes away.

Doing that will help you get through the next significant downturn without fear and the temptation to sell stocks at the worst possible time.

3. Make Sure Your Investments Are Diversified

I’ve written a lot about investment diversification. Here is how we defined it in one of those posts:

“Investment diversification means you don’t want to have all your investment eggs in one basket. Having your investments spread across various asset classes (stocks, bonds, cash, real estate, etc.) helps manage risk.

Investment diversification reduces the risk of owning one asset class. Unlike the 2008 financial crisis, in most cases, investments do different things at different times. They don’t all go up or down at the same time by the same percentages. And remember, you only lose money if you sell those investments during the market drops.

Diversification reduces risks. A broadly diversified global portfolio exposes investors to markets around the world and diversifies risks that have no expected return. If we want an entirely market-based globally diversified portfolio, it should include allocations in the world’s markets. On average, world markets consist of 52% U.S, 36% foreign developed, and 12% in emerging markets. Most of us would not be comfortable having that much money in international stocks.”

4. Asset Allocation

Asset allocation describes the amount of money you have in the various areas of the market. At its most basic, asset allocation means how much money you have in stocks, bonds, and cash. Stocks and bonds describe broad asset classes. Stocks and bonds then get broken down into sub-asset classes for greater diversification,

It might start with U. S. stocks vs. foreign stocks. Foreign stocks might get divided into developed markets and emerging markets.

Within both foreign and U. S. stocks, asset classes get broken down further by separating the companies’ size (large, medium, and small) and if companies are value stocks or growth stocks. There are multiple ways to determine what makes a growth and value stock. I won’t get into that here.

Here’s what asset allocation looks like for a 50% portfolio in stocks and 50% in bonds (that’s the broad asset class mix).

We use asset allocation to accomplish two things:

• Diversification – As we saw in the previous section, that means having money invested in different areas of the stock and bond markets. Except for real estate, we have not included another great area of diversification – alternative investments.
• Risk reduction – The second, and many would say, the most critical reason for asset allocation is to manage investment risk. With higher risk comes a higher expected return. Stocks are riskier than bonds. Bonds are riskier than cash. The more money one has in stocks, the riskier their investments. In my view, investors should take only as much risk as needed to accomplish their investment goals. Anything above that is an unnecessary risk, in my opinion.

5. Control What You Can Control

Steps one through three are all things we can control. Spend time working on those things. What we can’t control is what the market does, especially in the short term. Yet far too many of us spend time looking at our portfolios every day, week, or month to see how they’re doing. That will drive you crazy.

It causes us to do things we shouldn’t do, like sell when we see our portfolio drop. If you can’t handle significant drops in value over short periods, consider these two things.

• You have too much invested in stocks.
• It would help if you weren’t in stocks at all.

If risk and return are related, which they are, then if you want higher returns, you will have to accept higher risk. However, there is a limit to that risk. It would help if you only took as much risk as you’re willing, able, and need to take. How do I know how much risk I need to take?

Go back to step #1 for your answer.

Final Thoughts

Crazy times don’t necessarily call for crazy reactions. Reacting out of fear, panic, or desperation rarely works. Making decisions during these kinds of emotions can be and usually is damaging. However, we see too many people making hasty decisions during these difficult times.

I’m not suggesting you do nothing. It’s always good to review your plans to see if you’re on track; to consider, especially in times like these, whether you need to make adjustments to those plans. However, I don’t want to see anyone make rash decisions about their investments because of what they see going on right now.

Review to see if you need to make adjustments. If you find it necessary based on rational analysis, by all means, make those adjustments.

I offer this five-step process as a roadmap to follow. Stay focused. Stay strong. Stay healthy. When we get to the other side of these crazy times, I’m confident you’ll be glad you did.

Previously published at Wealth of Geeks.

By Marjolein Dilven