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Are You Ready for a Stock Market Crash? Answer These 3 Questions to Find Out.

By Maurie Backman - May 25, 2021 at 7:18AM

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Stocks could tank at any time. Here's how to know if you're prepared.

The stock market has gotten a bit more volatile lately, especially with inflation fears spooking investors. While there's no telling when our next full-blown market crash will occur, it's important that you be ready for one. And if you're not sure whether you are, ask yourself these key questions.

1. Do I have three to six months' worth of bills socked away in the bank?

If stock values drop and you sit back, do nothing, and wait for them to recover, you'll come away just fine. It's when you go out and sell investments when they're down that losses occur.

The danger of living through a stock market crash is that you may find yourself in need of money at a time when your portfolio is down. And if you're forced to sell at a low, you'll have to eat that loss.

Person in suit with serious expression at table with computer

Image source: Getty Images.

That's why having money in the bank for emergencies is crucial. Sure, interest rates today are abysmal, and you'll earn next to nothing by keeping cash tucked away in a savings account. But if you have that safety net, it could be your ticket to avoiding a scenario where you have to tap your investments when they're down and lose money in the process.

As a general rule, it's a good idea to have enough money in savings to pay for three to six months of living expenses. That way, if you lose your job during a prolonged stock market crash, you'll have the option to cover your bills without liquidating investments at a terrible time.

2. Is my portfolio diverse?

The more diverse your portfolio is, the greater your chances of coming away from a stock market crash unscathed. Now during a broad market crash that hits every segment equally, it may not matter whether the bulk of your stocks are in tech companies versus banks versus energy providers. But if a crash occurs where some segments are disproportionately impacted, then having that diversity is key.

Not only should you aim to own at least 12 different stocks, but they should be spread across at least three different market segments. Or, you can achieve diversity in your portfolio by loading up on exchange-traded funds or index funds.

3. Do I have a solid investing strategy in place?

If you're the type of person who buys stocks on a whim, or tries to chase the lowest share prices, then you may get hurt when a market crash arrives. A better bet is to have a solid strategy in place -- one that doesn't have you abandoning the stock market when things get dicey or aiming to time the market and potentially losing out on opportunities in the process.

For many investors, a system known as dollar-cost averaging works well. With this setup, you commit to investing a certain amount of money at preset intervals, regardless of market conditions or stock prices.

If you're signed up for an employer-sponsored 401(k), you're actually already employing this strategy by having contributions to that plan deducted from your income and invested automatically each month, but if you have a separate brokerage account, it pays to get yourself on a steady investing schedule. That way, you'll also be less likely to act irrationally if emotions get the better of you during a period of market volatility.

We don't know when our next major stock market crash will happen, but if history tells us anything, it's that gearing up for one is crucial. Be honest with yourself about how prepared you are, and if you're not at all ready, make changes as necessary to put yourself in a better position to withstand a crash before circumstances change for the worse.

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