In the past 70 years, the S&P 500 index has lost at least 10% of its value on 38 different occasions. So it's inevitable that it's going to happen again. But here's the good news: The S&P 500 recovered from all 38 of those crashes.
While stock market corrections and short-term volatility spook a lot of investors, there's no reason to live in fear of another stock market crash. Your investments can recover -- and even emerge stronger -- if you don't run when stocks plunge. Here are five steps you can take to prepare.
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1. Do nothing
If you have a long time horizon and you can deal with the stress of seeing your investments nosedive in the short run, the best thing you can do is nothing. When people fear a crash, they often stop investing. Or they cash out or rebalance too conservatively. Any of these strategies is far more likely to hurt your long-term returns than a market crash.
Consider the words of mutual fund magnate Peter Lynch: "Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves."
2. Build your emergency fund
Selling off after a market crash can devastate your long-term returns. But if you have enough cash set aside that you could live off of for several months and you commit to staying invested, you don't have to be afraid of a market crash.
If you don't have an emergency fund that could carry you for three to six months, now is the time to focus on building one. It's vital that you keep that money out of the stock market. The best place to store your emergency fund is an FDIC-insured account, like a savings account, money market account, or short-term CD.
3. Rebalance with caution
Because the coronavirus crash and subsequent recovery are both still fresh in your mind, now is a good time to review your risk tolerance and make sure it lines up with how you actually reacted when stocks were plummeting.
That said, think very carefully before rebalancing because you're worried about the market's near-term performance -- particularly if you're thinking of shifting to a more conservative allocation and you have a decade or more until retirement. When you go with a lower-risk portfolio, that generally means you shift some assets from stocks to bonds.
Near-zero interest rates mean rock-bottom bond yields that may not keep up with inflation. Plus low interest rates push bond prices higher. Investors with a long time horizon should worry less about short-term volatility and more about missing out on the growth that's needed to build a healthy nest egg.
4. Diversify beyond stocks
It's tough to build a diversified portfolio by hand-selecting your own investments. If your portfolio consists exclusively of individual stocks, now is a good time to diversify by adding index funds to the mix.
But if you're really worried about the overall market, investing a small percentage of your portfolio in assets that have a low or inverse correlation with stocks may set your mind at ease. For example, gold tends to move inversely to the stock market. You can invest in a gold ETF to give you exposure to the yellow metal without physically buying it. Another option is real estate, which has a low correlation with stocks. Investing in a REIT, or real estate investment trust, can help you diversify without buying actual real estate.
5. Set aside cash for your stock wish list
A stock market crash is a prime opportunity for buying stocks you've been eying at a bargain price. So if you're well-prepared for an emergency, consider making a wish list and putting money aside so you can buy after the market drops. Even if you don't invest in individual stocks, setting aside money to invest in an S&P 500 index fund after the market tanks is a good strategy. Then, while other investors are running panicked, you'll be ready to pounce.
