The stock market has experienced an unforgettable year. After the S&P 500 lost more than 30% of its value in a matter of weeks during the early stages of the coronavirus pandemic, the market made a remarkable recovery and ended the year at a record high. During the first month of 2021, the market has continued to climb higher and higher.
Some investors believe, however, that all this upward momentum is unsustainable and that another crash is on the way. While it's impossible to predict for sure what the future will bring for the stock market, it's wise to be ready for anything. Here's what I'm doing to prepare my investments for a potential market crash.
1. Maintain a strong emergency fund
I always like to have at least six months' worth of savings stashed in an emergency fund just in case I'm faced with an unexpected expense. But during periods of market volatility, it's even more important to have some savings set aside.
During market downturns, stock prices drop. If you're forced to withdraw your investments when prices are lower, you could end up selling them for less than you paid for them, thereby locking in your losses.
You never know when unexpected expenses will arise, and I prefer to play it safe to avoid withdrawing any money from my retirement account. When my dog needed a $4,000 surgery last month, my emergency fund was a lifesaver. Without emergency savings, I might have had to pull that money from my retirement fund. And if stock prices had been at rock bottom when I made the withdrawal, that could have had a disastrous effect on my investments.
2. Continue to invest consistently
No matter what the market does, I plan to continue investing consistently. I have my investments set up so that I'm automatically transferring a set amount from my bank account to my retirement account every week. Even if the market crashes, I'm going to keep investing as usual.
I like this strategy because I'm a long-term investor. It will be decades before I retire, so even if my investments lose value during a market crash, I have plenty of time to let them recover. Also, I invest primarily in low-cost index funds and mutual funds, so there's a good chance my investments will bounce back after a market crash.
It might seem counterintuitive to invest when the market is down, but that can actually be a smart strategy to get more for your money. When the market is down, stock prices are lower. In other words, the stock market is essentially on sale, and you can snag great investments at a discount.
3. Don't try to time the market
Timing the market means trying to buy and sell stocks at just the right moment to make a profit. On paper, it sounds like a smart strategy. If you buy stocks when prices are at their lowest and then sell when the market peaks, you could potentially make a substantial profit.
In real life, however, this tactic is nearly impossible to pull off. Nobody can predict exactly when stock prices will rise or fall. Some talented market forecasters can make solid guesses about what the market will do, but even the best forecasters may be wrong more often than they're right.
For these reasons, I never attempt to time the market. I continue investing each week regardless of what happens. If the market takes a turn for the worse, I just remind myself that it will recover eventually, so there's no need to panic.
Bonus tip: Don't check account balances
I will admit, I have gotten a bit of a thrill out of checking my investment account balances over the past year as stock prices have soared. But during market downturns, I make a point of not checking my accounts. In fact, I will sometimes delete my brokerage app from my phone so I'm not even tempted to check my balance. This doesn't necessarily help me prepare for a market crash, but it does help me get through rough patches without being tempted to sell in a panic.
Regardless of whether the stock market crashes in 2021, I like to be prepared just in case. By making sure my finances are ready for anything, I can rest easy whatever the future may bring.