Everyone loves investing when there is a Bull Market. Stock prices keep climbing and climbing so people are comfortable buying at any time with the expectation that stock prices will continue to rally. As long as the Bull Market continues, stock investors continue to buy. What happens though when the market makes a turn that’s longer than expected. Do we sell everything and panic? Do we hold it with no regard to downward risk? Some will advocate both of these options and we’ll go over these as well as five other ideas to consider. Below are 7 strategies to show you how to invest in a Bear Market.
1. Do Nothing and Continue to Hold
This is the advice that many financial adviser and “industry experts” give. The idea behind this is that historically Bear Markets are always short-lived and eventually the Bull Market will resume and make up for losses. This means that you accept all the risk of the downward move and are banking on stocks recovering to new hights.
Although historically this is true, sometimes it can take years for stocks to recover their prices and depending on where you are in life, waiting may not be an option. Generally, the older an investor is, the more negatively this strategy can affect them whereas younger investors that intend to keep their money in the market for decades to come will probably have nothing to fear using this strategy.
As you see in the graph below from 1902 to 2015, even though there are very drastic dips in price, notably in the 1930s (The Great Depression) and more recently in 2008, the market generally continues an upward trend over time. The younger you are, the more willing you may be to take this route whereas if you’re a year from retirement, this prospect can seem completely insane!
2. Take Some Money Off the Table
This is a way of staying the course with some of your money but tucking some away for safe keeping. For some this approach makes a lot of sense because this limits some downward risk but allows the market to play out and hopefully bring what is left in stocks back to its former prices.
Although this keeps some money “safe,” it also locks in some loss. Whatever you take out of the stock market is now at a loss from where it was before the bear market began. Still, this at least protects what you do take out until the market volatility subsides a little.
In order to do this smartly, I would recommend searching your portfolio for the stocks that are the most overvalued since they will probably be the most at risk until the market steadies out. This strategy is also known as “selling to the sleeping point” which means sell enough so you can sleep at night. You can read more about this strategy at Kiplinger’s website.
3. Put All of Your Money in Cash
This is exactly what it sounds like. You take all money out of equities and keep it out of the market till you think it’s safe to return. Selling off equities will lock in losses but prevent further losses. Once you feel like the market has turned, you can slowly re-enter.
If the reason you pulled out was due to the fear of the bear market though, you will not be alone. What’s important though is to not be drawn in too early when you start seeing the fear subside and people buy back in. Often times during a bear market, stocks will have short rallies as traders try to get in at a good price only to find that there is not enough true momentum for the market to reverse and it turns again and increases losses.
If you decide to get out 100%, I recommend reentering slowly by paying closer attention to fundamental analysis of stocks and getting back in because you believe in the company rather than the hype.
4. Use Hedges to Reduce Risk
There are a few ways to reduce risk by using some sorts of hedge trades. There are a couple ways to do this. First, you can use Inverse ETFs. This means buy shares of an ETF that trades the reverse of the market, so if the stock market goes down, the value of the ETF actually goes up. This ensures that although the rest of your stocks are still declining, the ETF will at least gain money to cushion the blow.
Another way to hedge your portfolio if it has more than 100 shares of a certain equity is to buy put options. A put option gives you the right to sell a contract (100 shares typically) for a set price by a certain date. If it’s February, you could buy a 60-day put that allows you to sell your shares for a set price regardless of how low it goes anytime before the expiration in April. This is a more technical trade and I would recommend you do a lot more research about options trading before attempting this or talking to a broker or financial specialist to help explain it better.
5. Set Stop Losses
This is not one of my favorite strategies but it is something to consider. This basically means setting a price in your brokerage account or speaking to your broker on the phone or in person to basically sell your stock if it hits a certain price. So if you have stock that is $200/share, you could set a stop loss at $180 so that if it hits $180, it sells your shares and prevents further losses.
What I don’t like about this is that there is a risk that the trade doesn’t go through. For example, if the stock was $190 at the end of one day and then opened the next morning at $175, it will have skipped over the $180 mark and not execute the sell order. Meanwhile, you may think you’re safe and in reality are continuing to lose. If you set a stop loss, you may consider paying closer attention to it.
Which Strategy is the Best?
Really, this depends on the individual. Some of these methods are more conservative than others. Taking all money off the table may be the safer bet for people closer to retirement but honestly if you are close to retirement, you should not have all of your money in the stock market. It’s just too aggressive.
So how do you know how much money you should have in the stock market to begin with? The “Rule of 100” is a very common thumb rule used by and taught by many institutions. It’s a really simple way to help ensure you are not over allocated in the stock market. Basically, take 100 and subtract your age. The number that’s left is the percentage of money you should have at a maximum in the stock market.
If you are 30 years old, don’t have more than 70% of your money in stocks. If you are 65, don’t have more than 35% of your money in stocks. This will ensure that the closer you are to retirement, the safer your portfolio is and the more likely that a huge financial downturn in the market won’t ruin your retirement years. The remainder of your money should be held in either cash (collecting small amounts of interest in a bank account) or in bonds.
Make sure you know the difference between stock and bonds. Cash and bonds are generally more conservative than stocks but offer a lower interest rate.
If you are younger, you may consider weathering the storm or pulling some out and reapplying it slowly as the market begins to turn. If you have any questions, seek a financial planner or professional money manager.
I hope you found this interesting, if so, please leave a comment below and share it with someone that you think may benefit from this.