Bear markets can be a scary time. Not only are billions of dollars in investments erased by the time the market loses 20 percent (the typical indicator of a bear market), but investors also start to lose confidence in stocks as a whole. That can potentially lead to a recession or even the bankruptcy of well-known companies (like the collapse of the Lehman Brothers during the 2008 Great Recession).
For the everyday American, this can be nerve-wracking. Especially for those people who are no longer working and living off of their savings, a decline of 20 percent or so is not something that’s going to fill them with comfort and security. In fact, it might lead them to take actions that can seem like a good idea at the time but cause even further damage over the long haul.
That’s why in this post, I’d like to go over a few key strategies that investors can use to protect their money when the markets crash.
Don’t Cash Out
It can be very tempting during a market crash to want to pull all your money out and put it into cash. This is a natural reaction to stop the financial hemorrhaging and try to preserve your savings before they disappear. But in reality, it’s a move that will likely do more harm than good.
Here’s why. Imagine for a second that you have a portfolio that’s worth $1 million. The market goes down and your portfolio goes down to $750,000. If you take your money out of the market and move it into cash, you’ll essentially lock in a $250,000 loss.
However, if you wait and do nothing, there’s a chance that it will return to its original value of $1 million. In fact, it will likely exceed it as more time goes on.
That’s exactly what happened during the Great Recession. Millions of people saw their 401ks cut nearly in half, panicked, and then pulled out of the markets completely. However, those that kept calm and waited saw their portfolios return to normal about 3 years later. In the six years that followed, the markets doubled in value again (which would have resulted in your portfolio growing to $2 million in our earlier example).
Minimize Your Spending
While you can’t control the markets, one thing you can control is how much money you’ll spend. And when the economy is in a bear market or even a recession, that’s the time to start tightening your belt. Here are three easy places to get you started.
Put off any major purchases. If you were thinking about finishing the basement or taking an expensive trip, you may want to hold off for a bit. It would be better to hang on to that money in case it’s needed than to spend it on something that could realistically be delayed for another year.
Eat more at home. People love eating out at restaurants, even though the prices and portion sizes aren’t necessarily good for us. If you eat more at home, not only will you spend way less than you would at a restaurant, but you’ll also have better control over your consumption by using better ingredients and taking in fewer calories.
Prepare a budget. Budgeting doesn’t mean cutting yourself off from buying stuff. Instead, it’s an organized plan for how you’re going to efficiently spend your income. That way you’ll prioritize getting the things you want and spend less on needless purchases.
Budgeting doesn’t mean you have to meticulously track your expenses or keep complicated spreadsheets. You can use a budgeting app like Buxfer to do all of that for you. Buxfer automatically connects to your bank accounts and credit cards and then imports this into one convenient dashboard. You’ll always be able to look at your Buxfer app and know if your budget is on track or not.
Have More Cash on Hand
Part of the reason that market crashes are so difficult psychologically to handle is that they make us feel unsafe. Even though we may not need our retirement savings for decades from now, our minds can make us believe that we’re in danger financially (even though most people never touch our nest eggs prematurely).
A good way to put your worries at ease is to build up a sizeable cushion of cash. By having cash that you can fall back on and use for whatever comes up, you’ll feel more secure about your savings as a whole and won’t be as concerned about what’s happening in the markets.
Also, if you’re already retired and living on your savings, having a cushion of cash can help insulate you from taking out more withdrawals than you have to while the markets are down. You could effectively live off of your buffer while the markets have time to recover.
Don’t already have a safety cushion? Try building it up by diverting some of your extra savings into an account that’s separate from your other savings. A simple strategy would be to set up an automatic transfer between your regular account and this new account where the money can slowly build month after month.
If you don’t have any extra savings to set aside, try picking up a side hustle. Commit to yourself that any extra money you make will go into this safety cushion.
Stay the Course with Your Investment Strategy
The main thing to remember when the markets are down is that this is normal and happened before. As uncomfortable as they are, market corrections and even recessions are a regular part of the economy. However, the good news is that they don’t last forever, and the markets typically recover anywhere from a few years to even a few months afterward.
That means your best course of action is to think long-term. Keep on investing and don’t diverge from your investment strategy. By doing so, you’ll dollar-cost average buying up equities when they’re at a discount and then having them increase later on.
For that reason, you may even want to get more aggressive and save even more to your retirement funds if you can help it. Though it can seem counterintuitive to throw good money after shares that are dropping in value, once things stabilize, you’ll be glad you did.
Prepare for the Next Time
Unfortunately, though it may not be something you want to hear while you’re in the middle of a market crash, the best time to start protecting yourself is during the good times when the markets are doing great. That’s when steps like perfecting your investment strategy and putting aside a cash cushion can be done without the pressure of the falling markets.
Remember this tip the next time the markets return to normal. Also, take a hard look at your asset allocation. If certain securities you thought were going to do well performed horribly or made you more anxious than you thought, then perhaps those aren’t the right ones for you.
Again, market losses are usually only temporary. Humans are emotional creatures, and we can sometimes let our fears get the best of us. But if you cash out early or make any sudden moves, then you’re stuck with those consequences forever. So please – no knee-jerk reactions. Stay levelheaded and let history be your guide.
Image source: Unsplash
Buxfer Blog 