Approximately two-thirds of investors believe we're currently in a stock market bubble, according to a survey from E*Trade. If -- or when -- that bubble will burst, however, is anyone's guess.
There's no way to predict exactly when a stock market downturn will occur, but it's safe to assume it will happen eventually. Market downturns are normal, and, unfortunately, they're also unavoidable. And after the remarkable rally the market has experienced over the past year, some experts believe a crash is on the horizon.
You may not be able to do anything to prevent a market crash, but understanding what it actually involves can be helpful to lessen the blow to your savings.
What happens to your money?
Many people associate market crashes with losing money. But what actually happens with your savings is more complex than that. And if you take the right steps before a market downturn, you may not lose any money at all -- regardless of how bad the crash ends up being.
A market crash essentially means that stock prices across various sectors of the market take a sharp decline. Many investors start selling their shares at the same time, and stock prices fall. When this happens on a broad scale, a market crash can occur.
When stock prices fall, your investments lose value. If you own 100 shares of a stock that you bought for $10 per share, your investments are worth $1,000. But if the stock price falls to $5 per share, your investments are now only worth $500.
However, the important thing to remember is that the loss isn't necessarily permanent unless you sell. Your investments may only be worth $500, but unless you're selling right now, that price doesn't matter. If you hold onto your stocks and the market recovers, the stock price may bounce back to its original $10 per share -- or even higher. You're back to where you started, and you haven't lost any money.
How to survive market crashes
Market crashes can be intimidating, but they don't have to be. Again, the fastest way to lose money in the stock market is to sell when stock prices are down. As long as you don't sell during a downturn, you have the ability to see those losses disappear if prices recover.
One of the best things you can do to get through a market crash is to invest in solid companies and hold onto your investments for as long as you can. Even if the stock price falls significantly, strong companies will generally be able to pull through. And by holding onto these investments until they recover, you can avoid losing money permanently.
It's also wise to diversify your portfolio. Aim to invest in at least 10 to 15 different stocks across various industries. That way, if one or two companies don't bounce back after a market crash, it won't tank your entire portfolio.
Choosing the right stocks
Index funds are groups of stocks that mirror stock market indexes, such as the S&P 500. Broad market indexes like the S&P 500 are good representations of the stock market as a whole. And historically, the stock market has always recovered from even the worst crashes. That means that when you invest in index funds that track the market, your investments are very likely to bounce back.
In addition, index funds provide instant diversification. Many index funds contain hundreds or even thousands of different stocks all bundled into a single investment. This takes much of the guess-work out of investing, because you don't need to choose which individual stocks to invest in or worry about whether your portfolio is diversified enough.
Market crashes may be inevitable, but that doesn't mean you can't prepare for them. By putting your money behind solid investments that can survive market volatility, you can rest easier knowing your money is safe.