With the stock market near its all-time high, few investors are terribly worried about their portfolios right now. But that makes now the best time to take steps to panic-proof your portfolio in preparation for the next financial crisis to rear its ugly head -- whenever that may happen.
Once panic sets in, it's incredibly difficult to make smart investment decisions -- and that's when people make costly mistakes with their portfolios. Here are five things you can start doing now that should help keep the panic at bay the next time stocks take a stomach-churning plunge.
1. Make Sure You Have Cash for a Rainy Day -- and a Fire Sale
In tough times, having an emergency fund to help you meet unexpected financial challenges is essential. The usual target is a cushion large enough to cover living expenses for three to six months. But having more cash on hand not only gives you more peace of mind, it also gives you a chance to take advantage of investment opportunities if more attractive conditions arise.
2. Rebalance Your Portfolio
The key to matching up your investments with your appetite for risk is to use an asset allocation strategy that guides you on how much of your money you should have in different types of stocks, bonds, funds, and other investments. Over time, as different investments earn different returns, the actual percentages of each you have in your portfolio can change dramatically. Rebalancing takes some of the profits on from past winners and reallocates them, pulling your portfolio proportions back into line and keeping your risk level where you want it. That will help you to take any future declines in stride.
3. Lighten Up on Big Bets
Making a smart call on a particular sector can earn you huge profits. For instance, after struggling for years, U.S. solar stocks First Solar (FSLR) and SunPower (SPWR) hit bottom last year, and lately, they've both made big runs higher as solar power gets cheaper and more widespread as an alternative energy source. But if you've managed to double or triple your money in these stocks, trimming back on your positions will ensure that you hang on to at least some of those profits. Moreover, in a pullback, you may well end up being able to buy back those shares more cheaply. And either way, the move will free up cash that you can use to invest in new stock prospects either now or down the road.
4. Find Safer Stocks
Getting out of the stock market entirely at the first whiff of danger isn't a viable long-term investing strategy. But what you can do is look at stocks that tend to behave better during downturns. For instance, during the 2008 stock-market crash, fast-food stalwart McDonald's (MCD) actually saw its shares rise. Consumer stocks like Procter & Gamble (PG) and Johnson & Johnson (JNJ) have also held up relatively well in down markets. But be careful: Stocks with these defensive characteristics have gotten very popular (and pricey) lately, increasing their risk and making them somewhat less safe than they'd be under normal conditions.
5. Make a Market-Dip Shopping List
There are plenty of attractive companies out there that trade at levels you simply can't afford to pay. Occasional stock-market panics are the investing equivalent of liquidation sales, where you can pick up your favorite companies at big discounts -- if you're quick on the uptake and ready to buy. During the market meltdown four years ago, smart investors bought stocks like Ford (F) and Sirius XM Radio (SIRI) at prices as much as 90 percent below pre-crisis levels, and then simply held onto them and rode them back up. By identifying the stocks you like the most now, you'll be first in line to grab shares at a big discount.
You can follow Motley Fool contributor Dan Caplinger on Twitter @DanCaplinger or on Google+. He doesn't own shares of the stocks mentioned. The Motley Fool recommends Ford, Johnson & Johnson, McDonald's, and Procter & Gamble. The Motley Fool owns shares of Ford, Johnson & Johnson, and McDonald's.
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