If you'd invested $10,000 on March 23, 2020, in the S&P 500 index, you'd have just over $17,000 today. That was the day stocks reached rock bottom during the apocalyptic COVID-19 market crash.
We had no way of knowing then that we had hit a bottom. And let's face it: When you see 30% of your wealth wiped out in five weeks, it's terrifying, no matter how much your rational brain tells you it's temporary.
Since 1950, the stock market has corrected, or dropped by 10% or more, about once every 1.84 years. So it's not a matter of if the stock market crashes again, it's only a question of when. Taking these six steps now will help you weather the next inevitable storm.
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1. Hoard cash in a savings account.
You only lose money in a stock market crash if you sell at a loss. But if your emergency savings are lacking, you risk having to do just that. Without sufficient cash reserves, a job loss or unfortunately timed monster expense could leave you with no other choice but to raid investments that have just tanked.
Aim to have six months of basic expenses stashed in a bank account or CD. If you get a 401(k) company match, keep investing to get the full contribution while you're building your rainy-day fund. But until you have sufficient emergency savings, seriously consider putting other investments on hold.
2. Set aside money for your stock watch list.
Not everyone can stomach throwing extra money into the stock market right after it's crashed. But if you have a high risk tolerance, a strong emergency fund, and no credit card debt, make a stock watch list and set aside extra money in a savings account so you can buy after prices have dipped. The key here is that these need to be stocks you'd want to own even if the market hasn't just crashed. A terrible company that you've bought on the cheap is still a terrible company.
3. Make sure you're not overexposed to one sector.
The top 10 stocks in the S&P 500 are mostly tech stocks, and they account for 27% of its weighting. So if you own S&P 500 index funds and individual shares of these top 10 stocks, you could be overly exposed to the technology sector.
That's certainly no reason to sell your winners. But if you have additional money to invest, you may want to diversify your portfolio by adding some defensive stocks, which tend to be stable even during a bear market. Consumer staples and utility stocks are good examples because demand holds steady regardless of the economic cycle.
Image source: Getty Images.
4. Sell stocks you don't want to own in 5 years.
If you own stocks that you've been meaning to sell, quit waiting for the perfect time and sell them now. This isn't a move you should make solely because you're worried about a stock market crash. But if you're holding on to a stock in a company that is losing its competitive advantage or no longer fits your investment thesis, it's essential to get rid of it while the market is still strong. The same applies if you need to cash out. The rule of thumb is to avoid investing money in stocks if you anticipate needing it in the next five years.
5. Don't invest on margin.
With margin, you essentially borrow from your broker to invest more money. All's well when the market surges because you amplify your returns.
But you also amplify your losses. If you invest $5,000 cash on a stock that plummets by 50%, your loss is 50%. But if you invest $5,000 of your money plus $5,000 of your broker's money, you've lost more than 100% because you'll owe your broker $5,000 plus interest.
As my fellow Motley Fool contributor Chuck Saletta described in March, your broker can change margin requirements in a panic, which could mean you have to liquidate investments right as stocks are plummeting. The vast majority of investors should avoid deepening the wounds of a crash and resist margin altogether.
6. Read up on past stock market crashes.
The final thing you should do to prepare is remind yourself that stock market crashes are normal. But even if the market tanked today, you have a 73% chance of positive returns if you invest in the S&P 500 in a given year. Over five years, your chances go up to 87%. Over 10 years, odds are 94%. And at no point in history would you have lost money investing over 20 years in the S&P 500.
The lesson is to stay calm and avoid making decisions in a panic. History tells us that another stock market crash is coming, but also that a recovery will surely follow.
