Most investors think in exactly the opposite way from how they should. When markets are testing new multiyear highs, as they have lately, they get greedy and think about how much more profit they can squeeze out of their positions. Only when the stock market has fallen substantially do they start thinking about taking protective measures to preserve those profits.
Yet after big upward market moves, the months of September and October have often proven to be turning points for the market. And while smart long-term investors don't necessarily make big changes when markets start getting frothy, what does make sense is to take a critical look at your portfolio and make sure you'd be comfortable with whatever the future may bring. It's a lot easier to figure out how to respond unemotionally to a market decline before it actually comes.
Here are some ideas for your to-do list.
1. Take the right amount of risk
In volatile markets, it's easy for risk levels in your portfolio to get out of whack. For instance, so far in 2012, technology stocks have been far and away the biggest winners, with Apple
All these swings can leave you with more concentration and higher allocations to risky assets than you want. If you act now, you can take advantage of divergent performance before it reverts back toward the mean, rebalancing to lock in some profits.
2. Have cash ready
Even when bank accounts pay next to nothing, having enough cash is important for a couple of very different reasons. If you rely on your investment portfolio to cover your living expenses, then it's much better to sell off assets when they're expensive to raise cash than to wait until a crash has already happened before selling.
But another reason to get your cash ready is to prepare for better deals on promising investments. Otherwise, you may not be able to jump on deals that won't necessarily last very long. By contrast, having cash on hand will give you the ability to place limit orders now that could automatically execute when prices reach a certain level, guaranteeing you the stock you want at the price you want.
3. Make a wish list
In connection with that last point, it's always useful to have a watchlist of stocks that interest you. But if you haven't done so, go a step further and try to figure out a price you'd be willing to pay.
For instance, despite Facebook's
I'm much more excited about Europe as a long-term play. While many expect the demise of the euro, I still think consumer-oriented companies will survive. So despite their troubles, France Telecom
4. Dump the hard stuff
By contrast, if you own some investments that seem too complicated to understand, now's a good time to get out of them. One example is BP Prudhoe Bay Royalty Trust
Do it now
Remember: Thinking about preparing for a downturn does you no good if you procrastinate until the downturn actually happens. Take steps to prepare today, and you'll be a lot happier whenever the next bear market comes.
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Fool contributor Dan Caplinger always tries to prepare. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Facebook, Apple, and France Telecom. Motley Fool newsletter services have recommended buying shares of Facebook, Apple, and France Telecom, as well as creating a bull call spread position in Apple. 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 is a good scout.