It's been a challenging time for investors, as the Nasdaq Composite (^IXIC 0.93%) has plunged into correction territory -- falling by more than 13% over the past three weeks. The S&P 500 (^GSPC 0.61%) is also inching closer to a correction, dropping by 9.3% from its high in February.
Many Americans were already worried about the stock market leading up to this sudden dip. Pessimism hit a 12-month high at the end of February, with 60% of U.S. investors admitting to feeling "bearish" about the market's future, according to a weekly survey from the American Association of Individual Investors.
Now, with stock prices plunging essentially overnight, many investors may be scrambling to figure out what to do with their investments. While there's no one-size-fits-all answer when it comes to handling market downturns, there's one critical move to avoid at all costs.
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Bear markets and recessions: What not to do
Perhaps the most important move to avoid when stocks are shaky is panic-selling your investments. Although it can be tempting to get out of the market and avoid losses, that strategy can backfire.
In some instances, even severe downturns are short-lived. In March 2020, for example, the S&P 500 lost more than one-third of its value in a matter of weeks as fears surrounding the COVID-19 pandemic surged. Yet, contrary to most investors' expectations, the market recovered almost as quickly as it plummeted.
Back then, selling your stocks a week or two into the downturn might have locked in serious losses. It may have seemed smart at the time, with many experts warning that a deep recession was ahead, but it would have been costly when stock prices quickly rebounded.
While all downturns are different and we have no way of knowing how long the current slump might last, it's always a good idea to remember that the market can be unpredictable. Timing the market is a smart move on the surface, but in practice, pulling it off successfully is next to impossible.
Fortunately, if you're worried about how to protect your portfolio going forward, there are three smart moves you can make right now.
1. Only invest in stocks with long-term growth potential
Now is the time to comb through every stock in your portfolio and double-check that it deserves to be there. Companies with shaky fundamentals are less likely to pull through difficult economic times, even if they have been thriving in recent years while the stock market soared.
Stocks from healthy companies are far more likely to survive economic rough patches. To determine whether a stock is healthy, it's wise to look at financial metrics -- like a company's price-to-earnings (P/E) ratio or price/earnings-to-growth (PEG) ratio -- as well as big-picture metrics like whether the company has a strong competitive advantage in its industry.
2. Strengthen your emergency fund
Selling your stocks after prices have already dropped can lock in losses. But if you keep your money in the market until prices rebound, your portfolio should regain its value.
During periods of market volatility, it's more important than ever to have a financial safety net in the form of an emergency fund. If you face an unexpected expense while stock prices are at rock bottom, you can lean on your emergency savings to cover it without having to risk selling your investments at a steep discount.
It's also possible to build up your savings without sacrificing your investments. In the previous step, did you identify any stocks you won't be confident holding through the downturn? Or do you have enough cash set aside for big expenses you know you'll have coming up in the next three years? That's money you're better off not investing right now.
3. Consider buying the dip
There's a major silver lining for investors when stock prices plummet: You can load up on high-quality investments at a fraction of the cost. If the market continues to sink, you could snag even steeper discounts on stocks.
Right now, then, is a smart time to think about what stocks you might want to buy on the dip. The more research you put into this now, the faster you can scoop up these stocks if or when their prices drop.
It's unclear whether we're headed for a recession or another bear market, but keeping a clear head is critical right now. By staying in the market, investing in quality stocks, and maintaining a long-term outlook, it will be a little easier to navigate these stressful times.
