In the last few weeks, we’ve seen a lot of resilience from the market but also a lot of negative headlines. And, now, investors appear to be reining in their exposure to some of the riskiest areas of the market. High-flying growth stocks and cryptocurrencies have pulled well back from their highs, and there have been a lot more earnings-induced “blow-ups.”
That’s not a guarantee that we see widespread weakness in the market, but it’s certainly raised the specter of a deeper correction and has many investors on edge.
Of course, we’re still within a few percentage points of all-time highs (within 5% on the Nasdaq and about 2.5% on the S&P 500), so we’re a far cry from investors streaming towards the exits.
But, if conditions deteriorate further, the 10% or 20% declines we’re seeing in former bull market leaders (like Nvidia (NVDA) or Tesla (TSLA)) could become more common.
So, rather than get caught flat-footed should that come to pass, it’s worth taking a little time to plan ahead. By doing a little of the legwork in advance, you can take steps now to help crash-proof your portfolio in the event that we face a steeper decline.
4 Steps to Crash-Proof Your Portfolio
Step 1. Set a price target the day you purchase your stocks.
Your target should be based on the P/E of your stock, multiplied by expected future earnings. Cabot Money Club’s Nancy Zambell recommends that you at least think about what price your stock can achieve within 18-24 months. And that should at least be a 30%-50% gain. If your stocks don’t have that potential, keep looking.
When the stock hits your target, reevaluate it and determine if it has the potential to continue double-digit price gains or if you would gain more by cashing in and using those funds to purchase a different stock with more potential. Many traders will also use that as an opportunity to cash in just a portion of a holding to take some profits and let the remaining half ride toward a new target.
Step 2. Set a stop-loss limit the day you purchase your stocks.
For aggressive investors, the stop-loss could be 30% or more. For more conservative investors, you might be happier with a stop-loss of 10%. It should generally factor in the volatility of the underlying stock. The actual percentage is not as important as being disciplined in exercising the stop losses. Sure, no one likes to lose money, but a stock riding momentum down can clean you out in no time, so it’s best to take your losses. If the stock bounces back, you can always buy back into it. Many of our Analysts provide stop losses for you, but it’s always a good idea to consider your own investing strategies when setting your stop losses.
Step 3. Diversify your portfolio to reduce your overall portfolio risk, as well as volatility.
That means creating a portfolio with non-correlated assets, which, theoretically, results in assets that react differently to market catalysts. When market action causes some of your assets to decline in value, others should rise, effectively providing protection against your entire portfolio declining at the same time.
Consequently, you should own small-, mid- and large-cap stocks; companies in different sectors; and both value and growth stocks.
And while you may think you are properly diversified because you may have 10 different technology stocks that operate in totally different segments, remember that they are all still technology stocks, companies that tend to do very well when the economy is steaming ahead and customers have plenty of money to upgrade.
Make sure you diversify across a broad range of sectors.
You should also have exposure to international stocks, either through owning multinational companies or via exchange-traded funds. And don’t forget about fixed-income investments. Some investors may want to add currencies, commodities and real estate to their portfolios.
Of course, the actual composition of your portfolio will depend on your personal investment goals, your age and your risk profile, so make sure you know the kind of investor you are so that your portfolio will match your investing style.
Step 4. Put some dividend-paying stocks in your portfolio.
They are a great hedge against inflation and provide terrific portfolio gains in down market cycles. Many investors neglect these companies as they think they are too boring. But, what’s boring about making money?
With so much cash available to companies over the past few years, stocks in every sector—including technology and emerging markets—will often pay a dividend. And that just adds to your profits.
For most investors, following these four steps will help you create a portfolio that will thrive through normal up and down market cycles. While an undiversified portfolio can give you tremendous gains—if you are lucky enough to choose only “home-run” stocks—the plain truth is that nobody has a crystal ball. And stocking your portfolio with just one type of company or sector—no matter how promising—is a recipe for failure over the long term.
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*This post has been updated from a previously published version.
