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3 Investing Strategies to Use If You're Worried About a Stock Market Bubble

By Katie Brockman - Jan 22, 2021 at 8:04AM

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Periodic bear markets are inevitable, but they're less unpleasant if you're prepared before they arrive.

The stock market has experienced remarkable growth over the past year even as the rest of the U.S. economy has been in shaky condition, and many investors worry that Wall Street is in a bubble that's about to pop.

Approximately two-thirds of investors believe we're already fully or somewhat in a bubble, according to a survey conducted by E*TRADE. In addition, around 60% of investors believe volatility will increase this quarter.

Stock market bubbles can wreak havoc on your investments, but don't panic. By taking advantage of a few smart investing strategies now, you can protect the value of your portfolio as much as possible.

Man with his hands in his hair looking at a stock market crash

Image source: Getty Images.

1. Adjust your asset allocation

Asset allocation refers to how your investments are divided within your portfolio. When you're young and have many decades ahead of you before you plan to retire, you can afford to allocate a larger portion of your portfolio to stocks. Even if the market crashes, your investments have plenty of time to bounce back.

However, if you're closer to retirement age, you may want to double-check that you're not investing too aggressively. If the majority of your portfolio is allocated toward stocks and the market plummets, you won't have much time to wait for prices to recover before you retire and begin to sell assets to help cover your expenses.

Determining your ideal asset allocation isn't an exact science, but to get a rough estimate, subtract your age from 110. The result is the percentage of your portfolio that should be invested in stocks. The rest should be invested in bonds or other relatively conservative assets. So for example, if you're 65, you may choose to invest around 45% of your portfolio in stocks and 55% in bonds.

Keep in mind that this is only a guideline. If you're particularly risk-averse, you may want to opt for a more conservative asset allocation strategy.

2. Put more money toward an emergency fund

It's always a good idea to make sure you have a sufficient emergency fund, but it's especially useful when the stock market is heading downward.

If your emergency fund is too small and you're hit with unexpected expenses, you may have no choice but to withdraw from your retirement savings. However, market downturns are poor times to do so, because you're selling when prices are low. So if you have some extra cash to spare right now, it may be wise to press pause on investing and stash it in your emergency fund instead.

3. Keep a long-term outlook

Although this past year has been unlike any other, remember that market downturns are normal. And no matter what happens, the U.S. market has historically shown an ability to recover. Whether it was the dot-com bubble of the early 2000s, the Great Recession, or the pandemic crash last spring, the stock market has managed to bounce back stronger than ever.

^SPX Chart

Data by YCharts.

Therefore, investors should avoid panic-selling based on near-term fears and concerns, and instead focus on the long term. Ideally, you should be investing for the long term already, buying solid companies that can withstand market volatility. As long as you have a well-diversified portfolio of such investments, it should recover in time.

Nobody can predict exactly how the stock market will behave in the short term, so it's impossible to say for sure whether this really is a bubble and whether it's about to pop. Regardless of what the future holds, though, taking these steps can help you prepare for anything.

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