Market crashes are an inevitable part of the market cycle. For most responsible investors, downturns aren't something to fear but instead are buying opportunities that provide a chance to buy quality investments at discount prices.
In some cases, however, a market crash could be a problem that affects your future financial security. This could happen to you if one or more of these three things applies to your situation.
Image source: Getty Images.
1. You don't have a diversified portfolio
Spreading money around to different asset classes and not putting all your eggs in one basket reduces how hard you'll be hit in a crash since chances are good that not all of your investments will perform poorly or fail to bounce back. Most people who have a diversified portfolio will get all of their money back and then some when an inevitable recovery happens.
Unfortunately, if you have too much of your money concentrated in any one company or industry, there's a chance you could suffer outsized losses if that business or field is hit especially hard by a market crash. That's especially true if the company never recovers or if economic changes result in fewer profit opportunities within the industry.
The good news is, you can fix this problem by taking a look at how your money is invested. If you notice your portfolio is too heavily weighted toward stocks or that you have too much exposure to any one particular company or sector, you can course correct before a crash happens.
2. You have the wrong asset allocation
Diversification isn't just about having a mix of different kinds of assets. You need the right mix of asset allocation given your age and level of risk tolerance.
If you're just a few years away from needing to start relying on your invested funds, you can't afford to have 100% of your portfolio in stocks. If the market does crash, it may not recover before you must start making withdrawals.
If all of your investments are temporarily down due to a market crash and you must begin taking money out, you're going to have to sell some investments at an inopportune time. You'll end up locking in losses that you could've avoided if you had other assets to sell instead.
The good news is, if you have an appropriate percentage of your portfolio in stocks and the rest of your money in other assets such as bonds, then not having a long investment timeline shouldn't cause heightened fear of a crash occurring.
Source: Getty Images.
3. You're likely to panic sell
Finally, you need to know yourself as an investor and understand your habits.
If you're likely to react in a panicky manner and sell your stock after a crash happens because you're afraid of further losses, you're probably not going to be a very successful investor during a downturn. You should fear a market crash in this situation because it's inevitable that your emotion-driven sale of your assets will result in locking in losses.
If this is the case for you, you must find a way to work on developing the confidence that you'll be able to weather a downturn and have your portfolio come back stronger. This may involve switching from investing in stocks to less volatile investments such as ETFs. Or, it may mean doing more research so you can develop enough confidence in your investments to hold on through tough times.
If you won't sell in a panic, have the right asset allocation, and have a diversified portfolio, there's no need to fear a market crash at all. So work on getting these three things right and you should be able to set yourself up for a more secure financial future.
