How to Prepare Your Portfolio for a Market Crash

2021 has seen a bullish year for investors as the market rally has sent the S&P 500 up 25% in 2021. By November 5, the big three U.S. stock indexes – the S&P 500, the Dow Jones and the Nasdaq – had closed at or near record highs (Vardy, 2021).

As many companies are currently trading at overvalued prices, many experts are speculating that the next stock market crash could be around the corner.

While one does not time the market, I do think that it is important to always be prepared for a stock market crash. After all, no one wants to wake up feeling panicky about their portfolios.

To gear up for the potential turbulence in 2022, here are 5 moves I will be making for my portfolio - regardless it comes to be or not.

1. Set aside a fund

In a time wheres stock indexes are hitting all-time highs, the market is bound for some bearish turns. It will always be towards your advantage to have some liquidity on hand, such that when such opportunities arise, you’ll be able to buy more shares of a great business at discounted prices.

2. Limit margin debt

Margin debt is the amount of money an investor borrows from the broker via a margin account, typically used to buy securities or short a stock. While margin is a great way to amplify returns, it comes with great risks. A dip in stock prices may trigger a margin call, forcing you to sell your investments and make a big loss on a great businesses. The risk is further amplified when its invested into overvalued markets. It is important to eliminate margin loans during these times as overvalued stocks can correct itself quickly, triggering a big margin call.

3. Create a list of investments to buy during the market crash

Market crashes are an outstanding buying opportunity as they are often brief and mild. Looking at the past 50 years, all the market corrections/crashes have been followed by a subsequent bull market rally.

While we are able to digest this information rationally at this moment, wild swings in the stock market may still trigger our emotions to drive our investment decisions, causing irrational decisions.

Preparing a list of companies to buy at an exact price before the big event will allow you to shop in a calm manner. Like how many of us start adding items into our shopping carts to snug up the discounts during the annual 12.12 sale, we should also start researching for quality companies such that we’re prepared to add more shares when the opportunity presents!

4. Evaluating your portfolio allocation

A well-diversified portfolio may be the secret to weather a stock market downturn.

Take advantage of the knowledge that a dip in a certain sector may be offset by a sector that experiences stability.

Personally, I would exclude any businesses that are easily affected by a new covid-variant. An example would be the tourism and hospitality industry, where the survivability of the industry depends on the covid situation. To ensure a rigorous portfolio, I will start to include defensive stocks that could thrive under the new covid-variant. This would include the HealthCare , Utilities, and Consumer Staples sectors.

5. Ensuring that you do not need the money in your portfolio for short-term needs

It is beneficial to evaluate your current financial position periodically, especially when a big purchase may be on its way. This is to prevent any sudden withdrawals from your portfolio as it is especially important to have the financial capability to ride out the market lows and reap the rewards of the future recovery.

Here are some general questions to ask:

1. Do you have an emergency fund equivalent to at least 6 months of personal living expenses?
2. Are there any upcoming major purchases like a new car? Or a new home?

3. Will there any significant changes in your income and expenses?

We can never predict where the market is headed, but we can always prepare our portfolios for the turbulence.

By setting aside cash reserves, limiting margin debts, reallocating portfolio position, strategizing about future investments and evaluating our financial positions, we could be well ready to deal with the turbulence that Mr Market throws at us in the coming year.