MMarket crashes are an inevitable part of long-term investing, but they don’t affect everyone equally. Some people comfortably weather the storm while others see much of their savings wiped out.
Often the difference comes down to the investment decisions made before and during the crash. If you belong to any of the following groups, you should probably adjust your investment strategy as soon as possible.
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1. People who do not diversify
Diversification protects you against losses by placing your money in many baskets. If you put all your savings into one or two stocks and they add up, you’ll lose a lot of money quickly. But it is unlikely that all investments will fall at the same time. Some, like bonds and gold, tend to do well when stocks are most volatile. Spreading your money among many investments minimizes your losses because when some of your stocks are going down you will have other investments that are doing better than normal.
While it’s a good idea to mix up the asset classes you invest in, you should also make sure you diversify within a given asset class. For example, you don’t want to invest exclusively in technology stocks. While there are many strong companies in this field, if new regulations or an unforeseen issue arose, it could affect the entire industry. Even if your money is split among several different tech stocks, you could still lose a lot in this scenario.
Invest in multiple areas to further reduce your risk of loss. Continuing with our example above, this could mean adding financial stocks and industrial stocks to your portfolio so that your money isn’t fully invested in tech stocks. But try to stick with companies whose business models you understand. This helps you better understand how a company’s movements will affect its stock price.
2. People whose portfolios do not match their risk tolerance
Your risk tolerance indicates how much variability you are comfortable managing in your investment portfolio. Risk tolerance is generally higher in younger workers and lower in older people. That’s because losing some of your retirement savings isn’t as bad when you’re decades from retirement as it is when you’re about to quit your job.
Those with a high tolerance for risk usually invest more money in stocks because of their higher earning potential. As their tolerance for risk decreases, they gradually move money to bonds and other less volatile investments.
It’s up to you to decide how much risk you feel comfortable with, but a good rule of thumb for retirement savings is to invest 110 minus your age in stocks. So if you’re 40, you’ll keep 70% of your savings in stocks and 30% in bonds.
You should remember to adjust your asset allocation periodically to keep up with changes in your tolerance for risk. Doing this is essential to minimize your losses in the event of a stock market crash.
3. People inclined to make emotional investment decisions
Even if you have diversified your investments and made sure that they match your current risk tolerance, there is a good chance that you will lose money in the event of a stock market crash. This is quite normal. But how you deal with this loss can determine whether it is temporary or permanent.
Some people decide to sell their investments in the hope of avoiding future losses, but in reality this eliminates the possibility of recouping those losses when the stock market rebounds.
Often times the best thing to do in this scenario – assuming you don’t have either of the above two issues – is to just wait. Avoid looking at your portfolio if it is stressful and trust that you have invested wisely.
If you regularly put money into your investment account, continue to do so on the same schedule as before. Buying when stock prices are low could earn you a big profit when they rise again later on.
Stock market crashes are an inevitable part of investing, so it’s important to familiarize yourself with the idea. If you follow the steps above, you shouldn’t have to worry about these crashes disrupting your long-term plans.
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