3 Ways I’m Preparing for the Stock Market Bubble to Burst

Not only did the stock market come roaring back from the coronavirus crash that occurred in February and March 2020, the major indexes followed their recovery by soaring well above their previous highs. Today, stocks are trading near their all-time highs, and the S&P 500 index is trading at a price-to-earnings valuation unseen since the dot-com bubble.

There are several reasons for investors to expect that these high valuations will persist. Personally, however, I’ve made some slight changes to my investment strategy over the past year as stock valuations have continued to climb.

Stock prices won’t keep going up forever. Image source: Getty Images.

1. Ongoing changes to my portfolio

I’ve made some noticeable shifts in my portfolio over the last 12 months. Last summer, I started buying more value stocks and dividend payers while putting less money into growth stocks. 

Additionally, I’ve found myself allocating more of my portfolio toward cash instead of buying shares at sky-high valuations. I aim to keep my cash balance to less than 10% of my liquid net worth (including bank accounts, brokerages, and other investments), but it’s starting to creep up toward that level, which has forced me to find investment opportunities. 

So far, those moves have resulted in new investments that are, as a group, underperforming the market — even after the rally in value stocks. But they have maximized my ability to sleep at night.

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That said, I’ve mostly held onto growth stocks despite their huge rally since the 2020 crash. I have also been opportunistic in buying more shares of some of my favorite growth stocks when pullbacks present me with a better moment to buy. 

Overall, my portfolio has become slightly more conservative over the past year. To be clear, I’m still steadily investing most of my contributions to my retirement accounts and brokerage account in various stocks. I’m just leaving more cash on the sidelines for now.

Some may see this as padding my emergency fund. But the extra cash sitting in my bank and brokerage accounts isn’t for emergencies. It’s for investing — which brings us to parts two and three.

2. Creating a list of stocks to buy and the prices I’m willing to pay for them

Every investor should have a watch list of companies they like that they’re looking for a reason to invest in. Your reason for not having done so yet could be as simple as the fact you don’t have any cash available to invest right now. Or as is the case for me, you could be looking for an improvement in the valuation of the stocks, either due to internal catalysts increasing the value of the company or a market correction decreasing the share price.

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Over the last year, I’ve built a growing list of stocks whose prices have managed to defy gravity despite my skepticism about their valuations. Many of these are growth stocks that I find attractive as businesses but whose stock prices are too high for me to comfortably invest in right now.

If you have a similar list, I implore you, don’t hesitate when a stock hits your buy price. It’s impossible to know if the decline was just a correction or a full-on bubble popping until well after the price bottoms. Trust your research and put your cash to work.

3. Researching and investing in alternative opportunities

There are a lot of ways to invest your money. A few areas of growing interest for me are real estate and cryptocurrency.

The real estate market has seen prices climb right alongside the stock market, but mortgage interest rates are still near historic lows. As a result, real estate investing may require a larger cash outlay for a down payment, but you can still get a good return on that cash. Buying a rental property can be an opportunity to add leverage to your investments and produce steady cash flow. Real estate can also provide good diversification from stock returns, although it has seen increased price correlation with the stock market over the last few years.

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The cryptocurrency market has also seen a huge run-up in prices, but the more research I do on opportunities in DeFi and blockchain applications, the more I think cryptocurrency will grow in importance to the global economy. After the recent pullback in crypto prices, I put some more of my cash into crypto. Cryptocurrency prices are also historically uncorrelated with U.S. stock prices, so buying tokens could be a good way to diversify your portfolio. 

Real estate and cryptocurrency aren’t for everyone. They each carry significant risks, especially compared to buying a simple total stock market ETF. There are also other investment options out there that carry varying levels of risk and potential returns. But if you do your research and have a good reason to invest, they can be good options to diversify and protect your portfolio as stock market valuations grow less appealing.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. 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.

View more information: https://www.fool.com/investing/2021/07/01/3-ways-im-preparing-for-stock-market-bubble-burst/

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