Five ways to prepare for a market crash

What you’ll learn:

• How investing regularly can help smooth out market movements
• Why it’s important to keep your emotions in check.
• How diversifying your investments can help.

Over the past few months, there has been plenty of speculation about when the next market crash is likely to occur.

Despite fears that political uncertainty both in the UK and overseas would lead to market turmoil, the FTSE 100 index of Britain’s largest companies has generally proved resilient year-to-date, although there have been bumps along the way.

However, past performance should never be seen as a guide to the future, and there are no guarantees that the index will continue to perform strongly and it might fall.

In the world of investments, a crash or a severe market fall is often referred to as a “market correction”. This correction is typically defined as a fall of at least 10% from a recent high.¹

No-one can say exactly when there will be a correction, but it’s important for investors to prepare their portfolios for any potential stock market storms. Bear in mind that investments can fall as well as rise, so whatever steps you take to protect yourself from market volatility, there’s a chance you could get back less than you put in.

Here, we consider five strategies to help safeguard your portfolio.

Focus on quality companies

Investors may want to maintain a focus on quality blue chip companies which are well-established, nationally recognised businesses with strong balance sheets to help them weather any downturn.

These companies are typically able to use cash reserves to shore up balance sheets in the event of a market correction, enabling them to pay consistent and reliable dividends to investors. Always remember though that dividends are not guaranteed. If a company runs into financial difficulties, it can reduce its pay-out, or even cut it altogether.

Other characteristics to watch for include relatively predictable earnings that haven't tended to suffer too much during periods of market movement, and the ability to achieve high returns on investment without having to rely on excessive borrowing.

Investing in individual shares is a risky approach, however, as you’re relying on the performance of just one or a few companies. An alternative option may be to consider a fund that can pick a wide range of UK companies that the fund manager believes to be the very best. Actively managed funds in the Investment Association’s UK All Companies sector include the LF Lindsell Train UK Equity fund, Artemis Income fund and the Merian UK Mid-Cap fund.

When you invest in an active fund, the manager aims to outperform the market compared to a specific benchmark, such as the FTSE 100 index of Britain’s biggest companies. For those who would rather go down the passive path to get broad exposure to the UK, where the manager simply mirrors the investment holdings of an index, there are funds available which track the performance of the FTSE 100.

Please remember that our mentioning these funds does not constitute a personal recommendation. If you are unsure where to invest, seek professional financial advice.

Stay invested for the long-term

As the old investment adage goes: “Time in the market is more important than timing the market.” It is impossible for anyone to know exactly when share prices might rise or fall, so investors should remain focused on their long-term objectives, rather than trying to guess when a correction will occur.

Adopting a ‘buy-and-hold’ strategy means that you stay invested throughout market cycles, helping prevent you from making any knee-jerk reactions during turbulent times which could mean you sell at just the wrong time.

As you’re holding your investments for the long term, it also means you’ll pay less in fees as you’re making fewer transactions.

Of course, no investment approach is without its downsides and there are no guarantees that you’ll end up with more than you put in, but the hope is that sitting tight during periods of volatility will pay off over the long term.

Invest regularly

Drip feeding your money slowly into the stock market means you avoid the risk of investing a big lump sum just before a market correction.

It also means you invest across a range of prices, so if there is a correction, your money will buy you more shares and less when it recovers. This means you effectively pay the average price over a fixed period, which can help smooth out market volatility.

Again, there are no guarantees that investing regularly will leave you better off – you could face the reverse scenario and end up with a loss, but it can help instil investing discipline as you’ll invest regardless of whether the price is high or low.

While there can be benefits to investing regularly rather than as a lump sum, you should remember the impact fees have on your investment. If you’re only investing small amounts each month, the minimum monthly fee could make it expensive and may exceed returns.

Keep your emotions out of investing

Whatever you do, don’t let your emotions dictate your investment decisions. It’s important not to be scared by a falling market, so always think about the reasons why you picked your investments in the first place, and refer back to this when you are feeling spooked.

Considering in advance how you may react to a market correction could help prevent you from making any expensive mistakes, and selling shares at a loss instead of waiting for an upturn in the market.

Remember too that corrections are going to occur and are an inevitable part of investing. They might be unsettling, but holding your nerve could be the best way to protect your investments.

Spread your investments

Investing in a range of assets across different sectors and geographical regions can help minimise losses during periods of volatility.

All types of asset, such as shares, bonds, property and cash offer the potential for returns, but they don’t always move in the same direction. Ensuring your holdings are properly diversified means that when markets are turbulent, hopefully parts of your portfolio will rise to offset falls in other areas.

If you’re unsure where to invest, seek professional financial advice.