A lot of investors have been waiting for months for a pullback, only to be confounded at every turn. Yet despite the market's resilience, the time to prepare for inevitable downturns in stocks is before they actually happen. If you don't act to protect your portfolio until after something bad happens, it'll be a lot harder to figure out what you need to do while you're dealing with the emotional turmoil of watching your stocks come crashing down around you.
Telling us what we already knew
Earlier this week, a simple action showed just how vulnerable high-flying markets are to even the whiff of bad news. When the ratings agency Standard & Poor's chose to put a negative outlook on the United States' AAA credit rating, it threw stock investors into a minor panic, as the market immediately sold off around 2% and stayed down throughout the day.
Yet the interesting thing about the sell-off was that it didn't seem to take the particular news that prompted it into account. In the wake of negative news about the ability of the U.S. to repay its debt, you might have expected Treasuries to tank and bearish bond bets to soar. Yet ProShares UltraShort 20+Year Treasury
On the other hand, you could have expected commodity-related stocks like Silver Wheaton
Looking at how the market has bounced back from its losses, it's clear that Monday's events probably won't make or break the bull market. But they do serve as a reminder that even when the stock market is strong, it doesn't take much to get herding investors running the other direction. You don't want them to take your portfolio down with them.
Staying outside the fray
That's why you should make sure to take a bird's-eye view of your investment portfolio on a regular basis. That way, you'll know if anything unexpected has happened with your stocks, and you'll be able to take action before some adverse event hits your finances harder than you thought it would.
For instance, one thing you should do on a regular basis is to go through portfolio rebalancing. By paring back on investments that have come to dominate your overall portfolio while adding to sectors that haven't done as well, you put yourself in the best position to take advantage of the natural cycles of the market -- and you also reduce the risk of being overly concentrated in overvalued assets.
Similarly, looking at the investing thesis behind your particular individual stock or sector bets can prevent a financial catastrophe. Often, as economic conditions change, so too will the reason you bought a particular stock. But if you don't sell, then you could easily see hard-earned gains evaporate.
Finally, when times are good, it's a smart time to figure out which stocks you'd like to own if they get less expensive in a pullback. For instance, core stocks Costco
Do it now
You never know when the next big decline may hit. As a long-term investor, little bumps in the road aren't all that important -- but it still pays to be ready for them when they hit. With the right preparation, you'll respond quickly to great opportunities and profit from them.
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Fool contributor Dan Caplinger is usually too early rather than too late. He doesn't own shares of the companies mentioned in this article. Costco, Coca-Cola, and 3M are Motley Fool Inside Value picks. Costco is a Motley Fool Stock Advisor choice. Coca-Cola is a Motley Fool Income Investor selection. The Fool owns shares of Coca-Cola and Costco. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy won't stand you up.