10 Ways to Brace Your Portfolio for a Market Downturn

We're only two months into 2022, but it's already been a rough year for stocks. The S&P 500 dipped into correction briefly, and tech stocks have fallen further as the Nasdaq was even flirting with entering bear market territory, a decline of 20%, at one point.

Among fears of the Federal Reserve raising interest rates, Russia's invasion of Ukraine, and a crash in high-priced tech stocks going back to 2021, there's a lot to be nervous about. However, that doesn't mean you can't do anything about it.

Keep reading to see 10 ways you can prepare your portfolio for a downturn.

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There's a wide range of volatility in the stock market. Some high-priced tech stocks surged by multiples in the early stages of the pandemic before falling as much as 90% over the past year.

Safe stocks are stocks that have a proven track record of withstanding recessions and a long history of operations. Stocks like Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B), Procter & Gamble (NYSE: PG), Coca-Cola (NYSE: KO), and Johnson & Johnson (NYSE: JNJ) all fit the bill. Safe stocks are often the kinds of companies that have been around since the 1800s and operate in industries like consumer staples, healthcare, and insurance -- businesses that are mostly unaffected by the state of the greater economy.

ALSO READ: Investing in Safe Stocks & Low Volatility Stocks

Another way to protect yourself from a sell-off is to look to dividend stocks. Dividend payers tend to be more reliable than non-dividend payers, especially in market downturns.

In particular, investors should consider dividend payers in recession-proof industries. A good place to start is to look at the S&P 500 Dividend Aristocrats, a list of 65 stocks that are in the S&P 500 and have hiked their dividend every year for at least 25 years.

Not only are these stocks that are well equipped to survive a volatile market, but a sell-off could offer investors a chance to scoop them up at a low price, taking advantage of a higher dividend yield.

Maybe the easiest way to protect yourself from a sell-off is to buy put options. Put options give you the right to sell a stock without the obligation. In other words, they can protect you from a sell-off in your stocks or in the broad market as you can buy options on an index like the S&P 500, as well as individual stocks.

Though put options can protect you from downside losses, you can also lose money on them depending on how the stock moves.

Buying puts are a form of hedging and are popular among some investors as a way to protect against losses without having to adjust your portfolio.

ALSO READ: How to Trade Options

Another strategy similar to buying put options is to use stop-loss orders. A stop-loss order triggers a stock sale at a price of your choosing.

Like with buying put options, there are pros and cons to using stop-loss orders. Stop-loss orders will prevent you from experiencing deep losses, but they can also trigger sales when the market dips only temporarily.

Since it's essentially impossible to time the market and even the best stocks can experience large drawdowns, you should only use stop-loss orders on stocks you're comfortable selling.

Nobody likes to see their portfolio shrink, but there's a plus side to declining stock prices.

If you're still a net buyer of stocks, a sell-off is actually good because it gives you an opportunity to buy stocks more cheaply.

If you're investing for the long term, a short-term sell-off shouldn't affect your strategy or your goals, and looking at it as an opportunity can also help your investing mindset.

As Warren Buffett famously said, "Be greedy when others are fearful."

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Presented by Motley Fool Stock Advisor
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In order to take advantage of a market downturn, you're going to need some cash on hand so you might want to consider selling some of your low-conviction stocks if you need to raise cash.

Investors tend to see cash as insurance for sell-offs. Not only does it limit your exposure to falling stock prices but it also gives you an opportunity to take advantage of sell-offs in stocks you'd like to buy.

It might help to have a percentage target like 5% or 10% of your holdings in cash to deploy in markets like the current one.

ALSO READ: Worried About the Market Correction? 3 Tech Stocks to Buy Right Now and Hold Forever

If you want to add stocks to your portfolio during a downturn, a good first step is to find stocks you're interested in and make a list with prices at which you'd be willing to buy.

You can make this easy on yourself by putting in a buy order with your brokerage at a price you're comfortable with.

You might be surprised at how far your favorite stocks could fall. We saw some incredible bargains during the coronavirus sell-off, and that could be the same here, especially in many of the tech stocks that were so pricey a year ago.

Making a watch list is a good way to prepare yourself to take advantage of an ongoing sell-off.

Another way to make it easy to invest during a downturn is to use a dividend reinvestment plan, or DRIP, as it's known. DRIP plans automatically reinvest your dividends to buy more shares of the stocks that are paying those dividends.

It's a great tool for accumulating wealth over the long term and for allocating your assets to stocks that can withstand recessions and market downturns as they've proven they can do that by continuing to pay dividends.

ALSO READ: Dividend Reinvestment

It can be scary to see stock market values decline, but investors all have to remember that volatility is part of the game. Without risk, there is no reward. If stocks only went up by double digits every year, everybody would have their money in the stock market.

Remember that on average a market correction, a drop of 10% or more, occurs once every two years. A bear market happens once every seven years, and a crash of 30% or more happens once every 12 years.

Those are historical averages and not mathematical laws, but they serve as a reminder that stocks have plunged many times in history and have always recovered.

If you find that you're overweighted toward one or two sectors, it might be a good idea to consider rebalancing your portfolio. The past two years were a reminder that no sector stays in favor forever. Tech stocks surged in early stages of the pandemic before falling over the past year, while energy stocks struggled before a recent boom on skyrocketing oil prices.

As an alternative, you could also invest in a low-volatility exchange-traded fund (ETF) like Invesco S&P 500 Low Volatility ETF (NYSE: SPLV), which will make the rebalancing easy for you by choosing low-risk stocks like Verizon, Procter & Gamble, and Waste Management.

5 Stocks Under $49
Presented by Motley Fool Stock Advisor
We hear it over and over from investors, “I wish I had bought Amazon or Netflix when they were first recommended by The Motley Fool. I’d be sitting on a gold mine!" It's true, but we think these 5 other stocks are screaming buys. And you can buy them now for less than $49 a share! Click here to learn how you can grab a copy of “5 Growth Stocks Under $49” for FREE for a limited time only.

A market downturn is a good time to remember the principles of long-term investing and revisit some of the thinking of Warren Buffett, who said, "A market downturn doesn't bother us. It is an opportunity to increase our ownership of great companies with great management at good prices."

It's also worth remembering that, over the long term, stocks have always bounced back. Though it may seem to difficult to hold stocks through downturns, selling is actually riskier than holding.

Still, taking some of the steps above could help limit your downside exposure and preserve wealth through the downturn.

Jeremy Bowman has no position in any of the stocks mentioned. The Motley Fool owns and recommends Berkshire Hathaway (B shares). The Motley Fool recommends Johnson & Johnson, Verizon Communications, and Waste Management and recommends the following options: long January 2023 $200 calls on Berkshire Hathaway (B shares), short January 2023 $200 puts on Berkshire Hathaway (B shares), and short January 2023 $265 calls on Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.