After more than a decade of robust stock market gains, it’s worth reminding yourself that market corrections are an inevitable part of investing. Stock market corrections tend to take people by surprise, but the truth is that they happen fairly regularly.
Predicting a market correction is difficult. However, given the inability to accurately predict market corrections, it is crucial to ensure that your investment portfolio is best positioned to withstand a surprise market correction.
Here are five steps you can take to prepare your portfolio for the dip.
Define your investment time horizon
Investors with a shorter investment horizon should consider less risky assets. A glide path is commonly used to identify the suitable asset mix at a given time. As an investor is nearing their retirement date, a portfolio should be tilted more toward lower-risk assets.
Sell profitable investments
If you believe stock prices are headed lower, you may want to sell some of your investments that are trading near their highs.
“Lock in some profits,” advises Craig James Ferrantino, a certified financial planner (CFP) and founder of Craig James Financial. “Selling some portion of investments that have done well, while preserving the principal amount you invested in the first place, is one way to prepare for a correction.”
Alternatively, you may want to establish a selling strategy that dictates when you sell stocks and removes any emotion from the decision. This type of strategy is a good way to manage anxiety about a selloff. It is particularly for investors who can tolerate a loss, but not much more downside.
Do your stock technical analysis
Reviewing the technicals of stock can offer helpful insights into how the stock performed in similar market conditions and what investors can anticipate looking ahead.
Technical analysis involves reviewing historical stock performance data and volume as a way to forecast the direction of a stock’s price. Technical analysis can help investors seeking to identify overvalued stocks and exit their positions before a market correction.
Have cash saved for expenses and emergencies
Every responsible investor should have cash on the side to cover all immediate expenses and a fund for emergencies. There is no clearly defined magic number for the amount of money one should hold onto on the side. However, most people will want to have 3-6 months’ worth of income to cover personal and/or family expenses.
Having an “emergency fund” will help you sleep at night when markets are in correction mode, and you see your investments take a temporary drop.
Rebalance your portfolio regularly
Changes to the market can affect your portfolio’s strategic asset allocation. Assets that have gained in value will comprise more of your portfolio, and assets that have declined in value will account for less.
Rebalancing involves selling positions that have become overweight in your portfolio. It is in relation to your strategic asset allocation and buying positions that have become underweight in your portfolio. This helps to better manage risk.
It’s important to remember that periods of falling prices are a natural and healthy part of investing. Investors who are concerned about this risk can consider strategies to help them limit their overall investment risk position.
Remember that despite several down cycles, stock prices have historically risen over longer time periods. Stock market correction for sure helps the stock markets to catch their breath and reach even high peaks.