How to Prepare for a Stock Market Crash

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How to Prepare for a Stock Market Crash

prepare for a stock market crash

Stock market crashes have been happening a lot more frequently recently, leading up to a lot of stress and panic selling, especially among beginner investors.

Not to be a fearmonger, but a significant sell-off in the market is always around the corner. That’s why you should always be prepared for any kind of volatility the market has to offer.

We’re living in a time when a tweet can cause the stock market to go down big. So in such times, it’s essential to prepare yourself for the worst anyway.

Now when we say a market crash, it doesn’t necessarily mean a complete economic meltdown like 2008 or 1929. It can just be a correction of upto 10%, but if you’re not prepared, even that can cause some serious damage to your portfolio.

In this blog, we’ll talk about what to do when the stock market crashes and the strategies you can use to take advantage of it. So let’s begin!

How to Prepare Yourself For a Stock Market Crash

Everyone’s investing strategy is different according to their age, financial goals, risk tolerance, and time horizon. And for the same reasons, you can’t simply follow a one-size-fits-all market crash strategy from a guru because it’s very likely that you and they are not the same people.

The things discussed in this blog are some essential points that everyone, no matter what your financial goals, risk tolerance, or age is, should follow in order to survive and potentially take advantage of a market crash.

Know Your Risk Tolerance 

Calculating your risk tolerance before you invest will not only help you select the right asset for your portfolio but will also help you decide the best time to buy them. 

Your risk tolerance has two components. First, your willingness to take a risk, which is more of a psychological thing. And the second one is your ability to take a risk, which revolves around your financial situation and age.

Knowing your risk will not only tell you the right time to buy an asset, but it will also help you not sell your current holdings at the wrong time. 

You must know why you risked the money in the asset or stock you’re currently holding. If there was a purpose or a solid reason behind it, then you should only exit your position once the purpose is no longer there. 

Panic selling defies the sole principle of investing, i.e., buy low and sell high. Because when you do panic selling, you’re selling when the markets are low. Panic selling only leads to regret when the market recovers, which it always does.

Have an Emergency Fund

It can’t be stressed enough how important it is to have an emergency fund.  Not having an emergency fund was one of the main reasons why we heard so many heartbreaking stories at the beginning of the Covid-19 crisis. 

An emergency fund is 6-8 months of your necessary expenses saved in a bank account or at a place where it is safe and easily accessible or convertible to cash.

Your necessary expenses include anything that your life depends on, including but not limited to, food, home, healthcare, etc.

Ideally, you should not risk your money in the equity markets unless you have an emergency fund set up. If you’re investing the money you need for necessary expenses, then there is a very high chance that you will end up losing it all. Why? We’ll discuss that in the next section. 

Remember, stock markets are more of a place to build wealth rather than earning a living. Not saying that it is not possible to make a living out of the stock market, but that too will require you to invest a significant amount first before you can reap daily profits.

Only Invest the Money You Can Afford to Lose 

You probably have heard the phrase “you should only invest the money you afford to lose” a painful amount of times. But the thing is, it is not just a legal disclaimer that you can hear and simply ignore because there is a very solid reason behind it. 

The biggest reason why you should never invest the money you need in the markets is psychology. If you’re investing in the market with the money that you need, you’re likely going to be way more emotional about it. 

And when the market crashes, you’re more likely to make an emotional or stupid decision with it like panic selling, which will lead to loss of that money.

It is also not recommended because God forbids if you actually end up losing all the money that you needed, then it’s going to be a serious threat to your financial future.

Now, I get it, all of your money is important, and you can’t afford to lose any of it. Does that mean the stock market is not made for you, and you should stay away until you have thousands of dollars to throw at it? Let’s discuss that in the next section.

Also Read: Financial Planning Before Investing in Stocks

Start Small and Be Consistent

If you don’t have a lot of money to invest in the market, then realize that you don’t NEED a lot of money to get started in the market. You can start small and grow big by being consistent. 

Start with whatever amount you’re comfortable with, like just $500 or even less, and then build upon it. Once you understand the market and your portfolio turns green, start contributing a small amount to it every month, like just $100.

You must stay consistent with your monthly contributions to let the magic of compounding effect work and rapidly increase your wealth in the long run. 

The key here is to only contribute the amount you’re at peace with, that you’re not going to spend on anything else. 

The question you need to ask yourself is, whether or not are you going to need the money you’re investing today in the next 5 years? 

The reason why you should think about the next 5 years is, even in the case of the worst market crash scenario, it only takes the market about 5 years on average to rebound and recover all the losses.

Create a Wish List of Your Favourite Assets 

After you have everything set up, and know your risk tolerance. It’s time to create a list of assets that suits your risk profile and financial goals, that you would absolutely want to buy if they ever come at a discount. 

It can include risky investments like small cap stocks, tech stocks, and even Bitcoin. Or lower risk assets like dividend-paying value stocks or gold. 

One thing that you should focus on while choosing these assets is diversification. You can’t go with all tech stocks or all Bitcoin. You can’t go with all risky investments, no matter how young you are. 

Diversification is vital because, in times of a big sell-off, diversification is the only thing that will help you save your portfolio from not blowing up.

Place Your Buy Limit Orders

If you’ve followed through till now, then you now know your risk tolerance and have a diversified list of assets that you’d like to buy at an optimal price.

Now it’s time that you set buy limit orders to buy those assets whenever they come at your price. This is powerful because the next time when the market crashes, instead of panicking, you would be celebrating. 

Placing buy limit orders in advance at key levels is important because a lot of us might not be sitting in front of the screen to place orders when the price reaches our level. 

Secondly, what happens a lot of times when the market is falling like crazy is, it’s hard to gather the courage to catch a falling knife, meaning buying when prices are going down. Buy limit orders help us come over that fear and automatically execute our trades at important levels.

Now, to bring all of this together and making your investment strategies unique to you, ask these two questions to yourself before placing your buy limit orders.

First, if I buy right now and the price drops even more tomorrow, will I be upset? And if I don’t buy right now and the price goes higher tomorrow, will I be upset? 

What we wanna figure out with these questions is, which way you’ll be more emotional. Will you be more upset about losing money or not making potential profits. 

Pick your answer and commit to it. This way, you’ll not only be less emotional in the market, but it will also help you prevent yourself from making any stupid decisions during a market crash.