Worried About a Stock Market Crash? Here Are 3 Things You Should Do Now

What if the stock market crashes tomorrow? It's a question worth asking, especially when investors worry that high valuations, enthusiasm for artificial intelligence, or economic uncertainty could trigger a sharp sell-off.

History has repeatedly shown that the S&P 500 (SNPINDEX: ^GSPC) can fall 20% or more from a recent high during a bear market, and individual stocks can suffer much steeper losses.

Nobody knows when the next crash will happen. But you don't need to predict it to prepare for one. In fact, the best time to prepare for a market crash is before it happens, when you can still make decisions calmly rather than react out of fear.

Here are three practical steps investors can take today.

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1. Make sure you won't be forced to sell at the wrong time

Imagine your portfolio falls 40% just as you lose your job or face an unexpected expense. You may have to sell stocks at depressed prices simply to pay your bills. That's a risk you can reduce now.

Start by building an emergency fund that covers three to six months of essential living expenses. Keep it somewhere accessible and relatively safe (like a high-yield savings account), rather than investing it in stocks.

Next, separate money you'll need within the next few years from money intended for long-term investing. If you're saving for a house deposit, tuition fees, or an upcoming retirement, you don't want those plans to depend on the stock market recovering quickly.

Finally, review any borrowing used to buy stocks. Debt can magnify losses, and margin calls may force you to sell when prices are falling. The goal isn't to avoid every market decline, but to make sure a downturn doesn't force you to sell good investments at the worst possible time.

2. Stress-test your portfolio

A rising market can hide risks that become obvious when prices fall.

Look at your holdings. Are you heavily invested in technology stocks? Do several of your investments depend on the same AI spending boom? Are you holding businesses because their fundamentals are strong, or simply because their share prices have been rising?

Consider this example: If one stock accounts for 30% of your portfolio and falls 50%, your total portfolio loses 15%, assuming everything else remains unchanged. Now imagine several large holdings decline together. Would you still be comfortable owning them? Review each company's revenue growth, profitability, debt, competitive advantages, and management. Ask whether your original investment thesis remains intact.

A market crash can punish excellent businesses alongside weaker ones. But that doesn't mean every stock deserves to be held through a downturn. If a company's prospects have deteriorated, don't use a lower share price as an excuse to ignore the problem. Conversely, don't sell a fundamentally sound business merely because its stock has fallen. In short, know what you own, why you own it, and what would make you change your mind.

3. Prepare a shopping list before prices fall

A market crash can be painful, but it can also create opportunities for patient investors. The challenge is knowing what to buy when headlines are frightening, and share prices are plunging.

Start by building a watch list of businesses you understand that have durable competitive advantages, strong balance sheets, capable management, and attractive long-term growth prospects.

Then estimate what each business is worth and decide what price would offer a sufficient margin of safety. For example, suppose you estimate that a company's shares are worth $100 based on reasonable assumptions. You might decide that $70 offers a more attractive entry point. That doesn't guarantee the shares will reach $70 or that your valuation is correct, but instead gives you a framework for acting when emotions run high.

Of course, it may be useful to have some spare cash to buy, but do keep in mind that there is a potential cost of doing so: Stocks may keep rising while you wait. Also, you don't have to invest everything at once. Buying in stages can reduce the pressure to identify the exact bottom.

How should investors cope?

Nobody rings a bell at the top of the market or announces when the bottom has arrived. Instead of trying to forecast the next crash, focus on what you can control: Protect your finances, understand your portfolio's risks, and prepare to buy quality businesses at attractive prices.

A downturn may still hurt. But preparation can help you avoid panic-driven decisions and recognize opportunities when others are focused on losses. In other words, we can prepare for a market crash -- it will inevitably come, though we will never know exactly when.

Lawrence Nga has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.