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How to Protect Your Personal Finances When the Market is Down

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Just when we thought the pandemic was behind us, a surge in delta variant cases during the summer led to mask mandates and other restrictions being reinstated, and our old friend uncertainty—uncertainty about our jobs, our health, and our future—coming back into the picture.

The “new normal” from last year has seemingly become our permanent reality, with many of us still working from home, jumping on Zoom (ZM - Free Report) calls, baking too much banana bread, and watching a lot of television.

Because of this, reviewing your personal finances is now more important than ever.

To avoid going into panicked, stressed-out mode, start by figuring out your net worth. Calculate how much cash you have on hand, what’s in your investment portfolio(s), and your current debt load.

By laying everything out on the table, from what you owe to how much money you’re able to bring in, you’ll be able to start to feel a little more in control.

Another key step: start, or add to, an emergency savings fund.

Despite the allure of online shopping, you may have found it easier to save your money this past year and a half, since bars, retail shops, restaurants, and movie theaters were all shuttered for a long period of time. Taking what you would have spent on dinner and a movie, for example, and putting it right into your piggy bank is a simple way to build up your fund.

But if you really want to ramp up your savings, write down all of the things you think you’ll be able to live without for a while, like your morning Starbucks (SBUX - Free Report) run or new fall clothes.

The more luxuries or non-essential items you can cut from your budget, the more you’ll be able to easily save and the bigger (and quicker) your emergency fund will grow.

Protecting Your Investment Portfolio

Last year, we saw the U.S. economy come to a screeching halt due to nationwide lockdowns, and the recovery has been slow, steady, and a little bit rocky. But big tech stocks like Microsoft (MSFT - Free Report) , Amazon (AMZN - Free Report) , and Facebook (FB - Free Report) have helped drive the major indexes to record highs, boosting investor sentiment across the board.

The underlying economic data continues to improve bit by bit, and the markets are beginning to price in the Fed’s bond purchase tapering.

But things could still get choppy—September has historically been a down month for the stock market, and the Dow and S&P 500 are in the red so far. One of the simplest ways to safeguard your investment portfolio in a volatile climate is diversification.

Portfolio diversity doesn't just mean owning five stocks from five different sectors. It also means complementing stocks with bonds, real estate investments, hard assets and/or cash investments.

The more diversified a portfolio is, the less vulnerable it is to broader macroeconomic events.

Additionally, avoiding high beta stocks and sectors and favoring those that pay dividends can help your portfolio thrive during a downturn.

Do You Cash Out?

Moving your entire portfolio, or at least a portion, to cash is a thought that may have crossed your mind ever since the market meltdown in 2020.

While most advisors will tell you to not do that, there is a scenario that you could consider if you are toying with the idea:

If you are in a place where you don’t need to take on any more risk and you have all the money you’ll need for a good retirement, then moving to cash makes sense.

But that’s a very rare situation.

Overall, the amount of cash you should hold in your portfolio depends on what type of investor you are and where you are in your investment journey.

For younger investors, there’s a good chance you can recover from any losses you experience now—history has shown that the market has risen after a downtown, surpassing past highs.

For retirees, it’s a bit different. Financial advisors usually recommend having more cash on hand, but still keeping two to three years’ worth of investments you can rely on as part of your income.

Something to always keep in mind, though, if you are thinking about or are tempted to cash out part of your portfolio is when you would you get back into the market. Timing the stock market is incredibly difficult, if not impossible, and you may miss out on dividend payments if you own stocks that pay those nice quarterly distributions.

Final Thoughts

Economic volatility is a good time for you to both reevaluate your personal finances and your investment risk tolerance.

But always remember: reducing your exposure to risk is never a bad thing. You just have to figure out what is best for you and your investment horizon.