After a wild and extremely volatile December, the stock market seems to have rebounded a bit in January, and investors are no doubt breathing a collective sigh of relief. But just because the past couple of weeks were a bit kinder doesn't mean things will stay like that for the remainder of the year. In fact, there's a good chance the stock market will take another massive tumble at some point in 2019, and perhaps take months to recover. And if you want to avoid the stress so many investors experienced in December, you'll need a backup plan.
The best protection against stock market volatility
You'll often hear that diversifying your investments is a good way to protect yourself from major losses in the event of a market downturn, and that's certainly reasonable advice. The logic is that if you have your assets spread out across a variety of market segments, you're more likely to have a pot of winners and losers. But diversifying will do you only so much good when the market tanks across the board, which is basically what happened in December. Sure, a few individual companies' stock values might have held steady, but when the major indexes tumble in unison, there's little the average investor can do to prevent his or her portfolio value from declining on paper.
What you can do to protect yourself from actual losses during a market downturn, however, is amass some emergency savings. The reason? If you have an emergency fund to tap, and that stash prevents you from cashing out investments at a time when they're down, you won't actually lose money when the market takes a dive.
Back in December, many investors saw their portfolio values nosedive to the tune of thousands of dollars per day. If you were one of them, it was undoubtedly demoralizing to log in to your brokerage account and see its value decline from previous highs. But as long as you didn't sell any investments during that time, chances are your portfolio is worth substantially more today than it was three or four weeks ago.
Now imagine what would've happened had you been forced to sell investments at a low to cover an unplanned bill -- say a home repair that sneaked up on you or a medical procedure your insurance provider wouldn't cover. You could've easily lost yourself thousands of dollars by virtue of bad timing.
And there lies the importance of the emergency fund. Life has a way of throwing unpleasant financial surprises our way, but if you have cash in the bank to cover those unplanned bills, you won't be forced to sell investments at a bad time and lose money in the process. Generally speaking, you should aim to have anywhere from three to six months' worth of living expenses in accessible savings. That target might seem arbitrary, but it's basically designed to either cover a major expense or get you through a period of unemployment. Either way, do yourself a favor and start building some cash reserves if you're currently behind in that regard.
While the stock market might be in a better place at present than it was in December, there's no telling when the next downturn will happen. Having some cash in the bank, however, will make things far less stressful when the next correction inevitably sneaks up on us.