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3 Pointers to Prepare Yourself If the Stock Market Corrects in 2021

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All of the previous market crashes have taught us one thing, that they come and go. You can’t entirely avoid them, but you can better prepare for them. Be it the pandemic-driven market crash last year or the 2008 financial crisis, markets recovered subsequently, and equities came out as the best-performing asset class.

Here are three tips investors can follow to tackle the next market weakness.

Build up a cash reserve

Investors who change gears appropriately during the bear markets make money. Those who acted during the epic selloff last year can confirm this. It indeed seems easy in hindsight. But it’s hard to stay calm in falling markets and go against the tide and pick up some bargains.

Market crashes damage your portfolios and trim your unrealized gains. But what they bring is worthy opportunities that one might not get during the usual course of investing. That’s why discerned investors don’t panic in crashes and rather buy aggressively. You can also use this excess cash for dollar-cost averaging. Of course, you should consider investing this excess cash only after allocating enough for your emergencies.

The legendary investor Warren Buffett believes in having a large cash hoard. His investing conglomerate Berkshire Hathaway holds around US$147 billion in cash. Interestingly, he did not invest it much during the last crash, and the pile continued to swell. He largely stayed put as he didn’t find lucrative opportunities even after the crash.

Having excess cash will allow investors to buy quality names at discounted prices. That’s why Warren Buffett claims, “I will never risk getting caught short of cash.”

Focus on defensives well before the market crash

Investors only focus on growth stocks and overlook defensives during the bull markets. However, as the turmoil starts weighing on bull markets, they gradually turn to safe, dividend-paying stocks. However, it is advisable to have around 20%-30% allocation to defensive stocks in any kind of market.

Consider top utility stock Fortis (TSX:FTS)(NYSE:FTS). Although it underperformed growth stocks, it provides unmatchable stability due to its stable dividends and slow-moving stock. Irrespective of the broader economy, defensive stocks like Fortis deliver consistent returns to investors. It has returned 14% compounded annually in the last 20 years, notably outperforming broader markets.

You might have to settle for relatively lower returns with defensive stocks. However, the diversification and stability they provide is more important while investing for the long term.

Plough your excess cash and pick discounted stocks

As earlier stated, stock market crashes bring rare buying opportunities. Be ready with your own watchlist of quality stocks that you might want to grab in market downturns. For example, a top Canadian tech stock Constellation Software (TSX:CSU) fell nearly 30% during the crash in March 2020. However, it soon recovered all the lost ground and is currently trading close to its all-time highs.

Constellation Software acquires smaller software companies and offers a range of vertical market software applications. The stock has created enormous wealth for its shareholders over the years. If you invested $25,000 in CSU stocks in 2011, you would have accumulated almost a million-dollar today.

Long-term investors should note that you can’t perfectly predict a stock market crash. However, you can certainly prepare for it.

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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Vineet Kulkarni has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Constellation Software. The Motley Fool recommends FORTIS INC.

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