How to Prepare Your Portfolio for a Market Downturn

Steps that you can take right now

What goes up, must come down…and then go back up again? Regardless of how well equity markets have performed over the last few years, downturns in the stock market and the U.S. economy are common. The severity of these downturns varies and is based on many variables. So…..what is your plan to successfully manage your portfolio before, during and after the next downturn? What factors should you consider before making any changes? While there are no perfect answers to any of these questions, there are strategies you can begin to implement to prepare for this eventuality.


What does your big picture look like?

It’s always a good idea to have a solid understanding of your personal and overall financial goals, both short and long term. Are you preparing to pay for a child’s college tuition in the near future? Are you close to retirement? Do you have a young family and need to support them both today and in the long term? Or, are you in your early thirties, in stable employment, without dependents and looking to grow your wealth?

Each of these possible scenarios would likely have differing abilities to tolerate the ups and downs of the market. Risk tolerance is the extent to which you, as an investor, can accept this volatility and the potential losses which may occur. Using a risk calculator, such as one from Riskalyze, can help assess your specific situation, taking into account multiple factors which may influence your tolerance. Investing strategies can then be created or altered accordingly.


Taxes

Are you working within a taxable account or tax deferred account (such as an IRA or 401(k))? If within a taxable account, you must consider the potential capital gains tax impact if sales are made. You also need to know if gains are short-term (held less than one year) or long-term (held longer than one year) as the tax rates are different. You do not pay taxes when you sell securities within your tax-deferred accounts. Instead, you only pay taxes when you take distributions from tax-deferred accounts.


Investment strategies to consider

  • Rebalance your portfolio to a more appropriate base allocation, between equities, fixed income, and cash.
  • Don’t be afraid to take profits.
  • Make sure you diversify. Some portfolios will be over-weighted or highly concentrated based on the growth of a certain stocks.
  • Reposition your equity allocation toward sectors that have historically held up better during market sell-offs. Consider defensive sectors such as utilities, energy, consumer staples or “value” oriented investments.


When to trade?

  • Timing the market is very difficult, no one knows exactly where or when the market top or bottom will be.
  • Devise a plan which accounts for your financial goals and risk tolerance, then use a disciplined approach for executing. In your plan, include a timeframe of when to make changes.
  • Keep in mind that changes do not have to be drastic or done overnight.
  • Consider trading taxable accounts over different tax years to spread the tax liability.
  • Think about employee-sponsored plans, such as 401(k)s, with the view of your “current allocation” versus “future contributions.”


While there is no certainty as to when the next market downturn will occur or how far the market will fall, it is an excellent idea to create a well-thought-out plan now. Those who are unprepared may find themselves feeling financially vulnerable and scrambling for answers. Some investors find that working with a professional investment advisor or financial planner can help assess your specific needs and create a plan designed to protect you in any economic climate. Everyone’s financial picture looks different and it probably makes sense to explore all options.

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