Are you ready for a 2021 stock market crash? Here’s why you should be

The stock market closed a memorable week on a relatively calm note on Friday. Mixed markets sent the Dow Jones Industrial Average (DJINDICES: ^ DJI) and the S&P 500 (SNPINDEX: ^ GSPC) down, but the Nasdaq composite (NASDAQINDEX: ^ IXIC) set another all-time high.

Data Source: Yahoo! Finance.

Many individual investors fear that after the huge acceleration of the past 10 months following the coronavirus bear market, stocks may have been too quick. Given this fear, you might think people would do more to protect their portfolios from a possible downturn in major stock indexes.

Still, there is a sign that institutional investors are not at all worried about an impending bear market. Oddly enough, this makes it cheaper than usual for those who make want to protect themselves in order to act now. Below, we’ll take a look at what you can do to protect yourself against a bear market without drastically changing the way you invest.

Image source: Getty Images.

Without fear

People can say that they are afraid of a potential bear market. But it’s smarter to see if people are putting their money where it is and actually doing something to protect their wallets from loss.

One metric that many investors use to gauge fear levels in the market is the CBOE Volatility Index. Also known as the VIX, this benchmark index examines the prices that investors are willing to pay for call and put options. By analyzing these prices, the VIX can determine what the market expects in terms of short-term market volatility.

When people worry about a possible downturn in the stock market, the VIX tends to rise. When this slowdown actually occurs, the VIX typically increases. For example, let’s take a look at the VIX over the past year.

^ VIX data by YCharts.

You can see in the graph how this works in practice. As 2020 approached, few people worried about a bear market, so the VIX was at extremely low levels. The spikes on the left correspond to the initial drop in late February and the crash that followed in March. Then, as the chart shows, once investors became more convinced that the markets would survive the pandemic, VIX levels returned to normal.

It would be reasonable to think that a surge in the stock market would translate into a steady rise in the VIX, as more and more people anticipated the possibility of greater volatility. Looking above, however, there is no sign of this concern.

Don’t be complacent – be prepared

This is certainly not the first time that investors have seemed complacent, even in the face of uncertainty. When stocks rise and markets have overcome huge challenges like they have during the rebound since the start of 2020, it’s easy to think that you will never have to suffer a lasting setback. This was true in the aftermath of the financial crisis over a decade ago, and it has played out the same way countless times in stock market history.

Rather than just blindly investing your money in all the stocks that grab your attention, the best strategy in market conditions like these is to stick with a long-term investment. If you focus on companies that have the potential to become industry giants in the next 10 to 15 years, then what happens next month or later this year becomes much less important. Over that long period, you’re almost guaranteed to see at least one or two big stock market pullbacks – but that doesn’t mean your stocks will suffer.

The other smart thing to do when the markets get volatile is to have some money aside that you can use to invest in the event of a crash. It’s still hard to do, but those who were able to pull the trigger and buy stocks as the market plunged in February and March now own stocks that have generated incredible returns.

Indicators like the VIX suggest that many investors are not ready for what the future may bring. By preparing yourself, you will have an edge over your peers and have a better chance of building wealth that will change your life in the long run.