Investing in the stock market can be an effective way to generate wealth, but the possibility of market crashes can be daunting. When you've been consistently investing for years or even decades, the last thing you want is for a market downturn to wipe out your savings.
To be clear, nobody knows for certain whether a crash is coming or not. Market downturns can be unpredictable, and it's impossible to know exactly when one will happen or how severe it will be. That said, you can still prepare for a crash regardless of how the market is currently performing.
While all investments are subject to short-term volatility, investing in the right places can give your portfolio a better shot at surviving downturns. Not all investments can withstand crashes, and there are a few signs your portfolio may be in trouble if the stock market takes a turn for the worse.
1. Your portfolio isn't diversified
Diversification refers to how many different investments you have within your portfolio. A well-diversified portfolio will often contain, at a minimum, 10 to 15 stocks from a variety of industries. To limit your risk further, you may opt to invest in at least 25 to 30 different stocks.
If you have a significant amount of money in just one or two stocks, you could stand to lose a lot if one of those stocks is hit hard during a market crash. Similarly, if you're investing in dozens of stocks but they're all from the same industry, a downturn within that sector could hurt your portfolio.
To give your investments the best shot at recovering from market volatility, it's best to double-check that your portfolio is properly diversified. When you're investing in dozens of stocks from several industries, your portfolio is likely to remain strong even if a few of those stocks don't perform well.
2. Most of your money is in short-term investments
Market downturns can be intimidating, but they are temporary. It may take months or sometimes years for the market to fully recover from a crash, but historically, it has always been able to bounce back.
The key to surviving these downturns, then, is to hold your investments for the long term. Your stocks may take a hit in the short term when prices fall, but by holding your investments until the market recovers, your portfolio will have a better chance of surviving as well.
Short-term investments can be tempting, because they often have the potential to earn explosive returns over a short period of time. But they may also have a more challenging time recovering from market downturns, making them a risky investment choice.
3. Your investments don't have strong fundamentals
Even if you do have a fully diversified portfolio filled with long-term investments, it's just as important to make sure you're only investing in healthy companies. Not all stocks are created equal, and some are stronger investments than others.
Strong companies have solid underlying business fundamentals. This means their financials are healthy, they're led by capable leadership teams, they're finding ways to grow and innovate, and they're maintaining a competitive advantage in their industry. Without these factors, it will be tough for a company to grow consistently, and it will be especially challenging to survive tough economic times.
Right now is the perfect opportunity to comb through your portfolio and check that each investment deserves to be there. Companies can change over time, so it's wise to examine your stocks every so often to make sure they're still strong investments.
Market crashes can be alarming, especially if you have your life savings tied up in your investments. The good news, though, is that there are ways to prepare for a potential downturn. By taking a few strategic steps, you can ensure your portfolio is solid no matter what happens with the market.
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