How to Prepare for a Market Downturn

After more than 20 years of studying and researching financial markets it still surprises me what is written about a possible market downturn.

I read about five financial reports every day, and if I didn’t know better, this week I could have believed the world was about to go into meltdown any moment.

The amount of fear in the media about financial markets being too high and property markets being in bubbles would be enough to make you run for the hills.

So I thought it was a good time to provide you with some tips on how to prepare for a market downturn…

It also reminded me of one of my favourite Warren Buffett quotes, “Be fearful when people are being greedy, and be greedy when people are being fearful”.

This is a great reminder of what you can do to manage a market downturn…

…Because in a market downturn, whether it is property or stocks, people tend to act with extreme fear.

The other significant thing to note about a market downturn, is that this is normally the time that the wealthy make their biggest gains.

Now the main caveat of this post is that I don’t know when the market downturn is going to come.

The key thing to note, is neither does anybody in the media.

In fact, the media is the last place you should be taking guidance about the markets.

Historically the media has been wrong almost every time when it comes to what markets are doing. And remember they sell news based on fear.

So what can you do to prepare for a market downturn?

How to Prepare for a Market Downturn

1. See the Bigger Picture

It is important to recall your financial goals and remember that you are investing for the long term.

So the first thing to acknowledge is that a market downturn will come during your lifetime, but you now know that markets always recover.

It may take some time, but stock and property markets will recover and continue to climb to new highs after a market downturn.

Being in the market is the absolute key.

2. Evaluate Your Portfolio

The amount of risk exposure in your portfolio will determine how well it performs during a market downturn.

If you own a lot of high-risk debt or stocks of new or struggling companies, you may experience greater loss during a market downturn.

Review your portfolio to determine if you have any investments that fall into this category and determine whether it would be wise to exit them prior to a market downturn.

Evaluating the risk of your portfolio before any market shocks gives you the time to make informed decisions while there is relative calm in the markets and to prepare an exit plan if one is required.

There will be stocks and maybe even properties that don’t recover after a market downturn.

The stocks that are vulnerable before the downturn are high risk of failing when markets crash.

3. Decide what investments to sell

Once you complete your evaluation of your portfolio, decide what investments you will sell before the market downturn.

As a tip, cyclical investments tend to perform poorly during a market downturn…

Cyclical investments are those that rely on consumer confidence and discretionary spending to survive, like consumer electronics, luxury goods and travel.

When people are fearful and cash flow is tight, these are the first things you tend to stop spending on. Companies that rely on this type of spending will suffer the most.

The other category to look at are investments in highly leveraged companies, that is, companies that have a high ratio of debt to total assets.

In a market downturn these companies will find it harder to repay their debt and hence struggle to maintain their value, or worse survive.

It is important to be decisive before the market downturn occurs in determining what, if any, investments you are going to sell. Don’t be caught up in the hype of picking the top of the market.

When you are prepared to give up some potential upside to manage the significant downside that could occur in a market downturn, you know you have reached a level of investing maturity that many others never achieve.

4. Build up your Liquidity

In a market downturn one of the first things that tends to happen is the access to cash becomes harder to obtain.

Banks tighten their lending practices as available cash becomes short in supply.

To ensure you have cash flow available to take advantage of opportunities that present in a market downturn, make sure you are building up your cash account leading up to the market downturn.

This could mean holding off adding to your regular stock investing plans to retain the cash for when everything becomes a little, or a lot, cheaper.

Now it is important to note that I am not an advocate for trying to pick the top and bottom of markets, and that I will always advise that you are putting money into building up your investments.

The main reason for this is that nobody knows when the market downturn or recovery will come…

…and if you listen to some of the supposed financial gurus, they have been predicting massive market crashes every year for at least the last three years, and yet most global markets have continued to surge higher.

So don’t fall into the trap of staying out of the market completely.

My suggestion is that you may reduce the amount you put into the market to retain a little extra in cash, so you are prepared for the opportunities that present in a market downturn.

5. Know the Products that Outperform in a Market Downturn

This is where you can gain some real ninja skill…

In a market downturn there are certain investment types that perform better than others.

Knowing what they are in advance, gives you the added advantage of using some of your built up cash flow to start accumulating these investments.

The first are simple government bonds.

The security of government backed bonds and the interest rate that they come with ensures that your money is safe, and you are getting some reliable cash flow to help meet your living expenses.

Next are the long-time favourites, precious metals, gold and silver.

Precious metals, especially gold are assumed to be safe and to hold their value in a market downturn.

As a result, it is common for gold and silver to surge in value as large investors, such as fund managers and retirement funds, put more of their money into these investments.

The final investment type to consider are counter cyclical stocks…

I’ve mentioned above the cyclical stocks that are likely to suffer in a market downturn, well the opposite is true of counter cyclical stocks.

Counter cyclical stocks or companies are those that outperform in a market downturn, normally because they are providing items that you and I consider essential for living…

These include utilities, consumer staples, such as food, and from a government perspective, defence related companies.

By knowing in advance that these are the type of investments that will do well in a market downturn, you can act decisively when the time comes to take advantage of these investments for better than average returns.

So there you have five tips on what you can do now to prepare for a market downturn.

The most important thing you can do is avoid panic…

There will be media everywhere talking about the massive losses in markets, and the stories of people who have lost great fortunes…

But remember, if you do nothing, all you have lost is paper value. You only realise gains or losses when you sell. And if you don’t sell into the panic, you haven’t really lost anything.

Markets always recover, so just keep on working your financial plan like I mentioned here and you will be continuing your journey to financial freedom with no money stress.

Let me know what you will be doing to prepare, I’d love to know what works for you. Leave a comment below and let’s get a conversation started, we can all learn from each other and help prepare together.