With the stock market approaching new highs, everything seems to be going right for investors. Yet memories of what happened back in 2008 are still vivid in many investors’ minds, and with the market environment having been relatively quiet and crisis-free for more than a year now, smart investors are looking past their greed to look for things that ought to frighten them about their investments, figuring that at some point, a pullback after the market’s impressive gains over the past four years is inevitable.
The right time to take steps to make sure you’re ready for whenever the next downturn comes is before that market crash actually happens. Below, we’ll take a look at some things to do right now, but first, let’s take a closer look at what has astute investors worried.
Waiting for the record to buy?
Stocks have had an amazing run in the past four years, with the Dow Jones Industrials having more than doubled and the S&P 500 gaining over 125% since their respective 2009 lows. Although the rally has come with some pullbacks along the way, investors have been rewarded for staying the course and buying temporary dips, with recoveries coming quickly and without much cause for alarm. Moreover, levels of concern about giving back those gains are very low, with the S&P Volatility Index‘s measure of investor fear near multiyear lows.
Interestingly, though, the move up in stocks hasn’t produced the usual performance-chasing that typically accompanies big bull markets. One reason for that may be that even with these impressive gains, stocks still haven’t recovered all their ground from their pre-financial-crisis highs. Until they do, many investors will remain skeptical of the market’s long-term health.
All that is poised to change if stocks manage to break through their 2007 all-time highs. Even though it may seem counterintuitive for investors to wait to pay more for stocks, the psychological boost of seeing the market having finally fully recovered from the most recent bear market could lead to a new influx of investment capital into the market. That in turn could spark the last big upward move in the four-year-old bull market, raising risk levels to the point at which prudent investors would need to start considering whether their stock portfolios were overpriced.
3 things to do now
With the stock market near a potential inflection point, making an extreme call is extremely risky. Slashing your stock allocation may seem smart after substantial gains, but if a further rally pushes stocks well above their all-time highs, your performance will suffer.
Instead, focus on measured responses to the current environment. First and foremost, make sure the risk in your portfolio is consistent with what you’re comfortable with. That applies both to your overall asset allocation and to individual stocks within your portfolio. For instance, big bull runs in 3D Systems Corporation (NYSE:DDD) and Stratasys, Ltd. (NASDAQ:SSYS) have produced massive profits for those who got in on the ground floor of those opportunities. Yet despite the potential that these companies have to revolutionize industrial prototype development and to change the way consumers purchase items like auto parts and hardware, if those stocks now represent the bulk of a highly concentrated stock portfolio, selling part of your position to diversify your holdings will reduce your risk level.
Second, beware of danger signs in your stocks. All sorts of different types of risks abound right now, whether it’s the threat of higher interest rates in the long run, exposure to government budget cuts, dependence on the reawakening of emerging-market growth, or tame inflation levels for much-needed goods and services. All of these risks have definite impacts on particular stocks, and if you own them, you need to be aware of the risks to decide whether or not the potential reward is worth holding on for. Sell any stocks whose stories you no longer believe in.
Finally, when in doubt, don’t be afraid to do nothing — except keep your eyes open. The temptation to take action is huge, especially with trading vehicles like ETFs making it easy to day-trade stocks, sectors, or entire swaths of the market. Doing too much is just as bad as not doing enough, and if you’re not careful, it’s easy to get into a situation where you’re whipsawing back and forth between wanting to buy stocks for their profit opportunities versus wanting to sell them in order to protect yourself.
Preparing for a market crash may seem like a downer, but it actually makes it easier for you to be optimistic about your investments. With a plan in place before the next crisis hits, you’ll be better able to respond the way you want if the worst does happen.
The article Be Ready Before the Next Stock Market Crash originally appeared on Fool.com and is written by Dan Caplinger.
Fool contributor Dan Caplinger has no position in any stocks mentioned. You can follow him on Twitter @DanCaplinger. The Motley Fool recommends 3D Systems and Stratasys. The Motley Fool owns shares of 3D Systems and Stratasys and has options positions on 3D Systems. Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.