If you've gotten into investing recently, you might be worried about the looming threat of a "trade war," and how that could impact your investments. Over the past few months, we've seen multiple days with plunging prices, mostly in response to the announcement of new tariffs on foreign countries or to news about other countries being willing to fire back.

If you're confused by what a trade war actually is, or what you should be doing when one develops, don't worry -- read on for a basic overview of what you need to make informed decisions for your investments.

Trade War Basics

Trade wars happen between two or more countries, usually when one country imposes a tariff or some other type of punitive action on another country's economic goods. In this case, everything started when Trump imposed tariffs on $450 billion of Chinese imports, after more than a year of threats. In response, China is threatening to impose tariffs on American imports, and Trump's proposed actions on other countries is inspiring even more external threats.

Trade wars are bad for almost everyone involved. The motivation behind tariffs is to discourage economic interaction with other countries, and keep spending confined within a single country. For some industries, this can be beneficial; the steel and aluminum industry in the United States, for example, may be able to charge higher prices and see more profitability. Unfortunately, companies that consume steel and aluminum will feel the burden, sending complicated ripples through the economy.

How the Stock Market May Respond

With tariffs in place, countries are discouraged from trading with each other, which limits economic growth on a global level. The fear of this potential outcome is what's responsible for sending stocks plummeting; when investors worry about the near future of the stock market, they tend to sell in droves, sending prices lower. The current volatility is merely an emotional reaction to the latest news.

In the near future, the profitability (and therefore value) of most companies, both American and international, may fluctuate based on new trade dynamics. This will vary by industry and by company, of course; companies that rely on inexpensive exchanges with another country (like China), or those with foreign production companies will suffer more than companies doing business almost exclusively in the United States.

In the distant future, a trade war is just another blip on the radar. Even the harshest economic recession will probably last less than a decade before things start turning around. If you're only worried about the long-term growth of your portfolio, try not to become too concerned about the short-term ramifications of a trade war.

Actions to Take Now

Before you take any actions, you should know that we're not in the middle of a trade war yet--and many experts believe a trade war won't happen at all. You'll have to base your next decisions on what you think about the trade war, and how conservatively you want to invest.

These are some of the options available to you:

  • Don't make any major changes. If you don't believe that a trade war is imminent, or if you don't believe it could have a major impact on the long-term health of the economy, keep your money where it is. Even if the economy takes a hit in the next few years, it will likely recover in another few years, and you'll be back on track.
  • Rebalance your portfolio to favor companies that would benefit from a trade war. If you think a trade war is coming soon, consider rebalancing your portfolio; for example, you could sell stocks of companies that rely heavily on other countries, and buy stocks of companies that operate domestically.
  • Keep some money in cash. If you suspect a recession is on the horizon, or if you're uncertain about the future of the economy, it's a good idea to keep at least some of your portfolio in cash. That way, you'll protect yourself from some of the impending market volatility, and you'll have plenty of money available to buy stocks if they dip in the future.
  • Diversify to hedge your bets. If you aren't sure what's coming next, the best play is often to diversify your investments. Make sure you have money in many types of assets, including ETFs and other funds that provide a basket of different investment types. That way, you'll minimize your risk and guarantee a more stable path of growth in the near future.

Of course, if you're playing the long game, investing in value companies with a multi-decade time horizon, you probably won't need to worry about a trade war at all. Keep watching the news for the latest updates on tariffs and the potential trade war, and stay informed so you can strategically direct your investments.