How to Protect Investments From a Stock Market Crash

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With any stock investment comes the risk of a market "correction," in which the value of your holdings will take a big downward adjustment. The possible causes are many. The event occurs unpredictably and in most cases gives ordinary investors little or no time to react. Any of several strategies might protect your financial well-being in the next stock-selling tsunami.

Raising Cash

  • Assuming the market crash will not accompany a global economic apocalypse, raising your cash allocation should buffer your portfolio. Fortunately, this doesn't have to mean collecting stacks of currency in your hall closet. Money market funds invest in short-term government and corporate bonds, pay a modest rate of interest, and strive to hold their share value steady at $1. The return on the investment will be low, but the safety (and convenience) of money markets will provide some peace of mind while the market sorts itself out. Money-market investors should be aware that new rules set in 2014 by the Securities and Exchange Commission allow money market funds to "float" their net asset value price above and below $1 and suspend redemptions during volatile markets.

Protective Puts

  • You can hedge stock market "event risk" by buying put options on individual stocks you own or on market indexes such as the Standard & Poor's 500. The option will rise in value when the stock or the overall market falls, allowing you to profit from the correction. Option contracts set a price and an expiration date. With a put, the option itself increases in value as the underlying stock or index drops. When the expiration date arrives, your broker will close out the trade at a profit or loss, or the put will expire worthless; you can also sell the option at any time prior to expiration. Index puts are used by experienced investors as well as mutual funds and institutions. You can purchase options through your broker, who will require an option-trading agreement that is, in effect, a waiver of the broker's responsibility if you should lose money.

Going for Gold

  • Buying physical gold as an investment may not be a great idea. Not only do you have storage costs, but there's no guarantee the price will rise even when the economy or the market is performing poorly. Nevertheless, in uncertain times, gold is a traditional, universal "go-to" commodity, and many advisers strongly believe in keeping a percentage of your money in either gold itself, gold-mining mutual funds or gold certificates. If the worst should happen and the value of paper currency falls off the table, the value of your gold will rise -- and the shiny metal bars can also serve as a medium of exchange.

Shorting Stuff

  • Shorting means selling without owning. When you short a stock, you're hoping it will drop in value so you can cheaply buy it back (which you must). Shorting is risky because the potential loss is unlimited, but buying into a short-selling exchange-traded fund allows you to spread the risk, limit your downside and give the logistical headaches to professional managers. The ProShares Short S&P 500 fund shorts the entire index. If you want to focus a bit, you can buy into "inverse" or "bear" ETFs that concentrate on sectors such as financials, health care or consumer goods. Also interesting are "country bear" ETFs, which bet against risky national economies (Russia, Brazil), and ETFs that look for hot, overvalued stocks that would be most vulnerable during a market crash.

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