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3 steps I’d take to protect my portfolio from a stock market crash

The 2020 stock market crash could cause investors to become increasingly concerned about their portfolio’s capacity to survive an uncertain economic outlook. After all, with many industries likely to suffer from reduced demand for their goods and services, it could prove to be an uncertain period for the stock market.

Through buying a diverse range of financially-sound companies with defensive characteristics, you could protect your portfolio from a future market crash.

Diversifying ahead of a market crash

Perhaps the simplest and most effective means of reducing your portfolio’s risks is diversification. Holding a larger number of companies reduces your reliance on a small number of businesses to generate capital growth or income, which is likely to make your portfolio returns more stable and consistent.

Furthermore, investing in multiple geographies and industries could reduce your overall risks. For example, the coronavirus pandemic is likely to affect some regions and sectors more than others. By having exposure to a wide range of countries and industries, you may be better able to protect your portfolio’s returns in the long run.

Fortunately, the cost of buying stocks has fallen significantly over recent years through the growth in online sharedealing. Therefore, diversification is cheaper and more accessible to a larger number of investors than it used to be.

Defensive stocks

Buying defensive stocks could limit your losses during a market crash. Defensive stocks are generally less impacted by an economic downturn than their cyclical peers. They may, for example, have business models that are relatively unreliant on the performance of the economy. This may allow them to deliver solid financial performances even during a recession or depression.

Examples of sectors where defensive stocks may be found include utilities, tobacco and healthcare. Although they may not necessarily offer capital growth during bull markets that can match that of cyclical businesses, they may continue to be relatively popular among investors during challenging market conditions. As such, their total returns in the long run could prove to be relatively impressive.

Financially-sound businesses

Another means of preparing for a market crash is to buy stocks that have solid financial positions. This may include companies that have modest debt levels, access to multiple sources of finance, as well as large cash balances. They may be able to withstand a period of lower sales or even losses better than their sector peers. This could make them attractive to investors, which may help to support their stock prices.

Through analysing company annual reports and investor updates, it is possible to build a relatively accurate picture of the financial strength of a business before buying it. Taking the time to understand its balance sheet strength could help you to avoid severe declines during a market crash, which could lead to higher returns from your portfolio over the long term.

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Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.