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How to Invest in a Bear Market: The Complete Guide

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Although markets have rebounded in the last month, making up or almost all of the losses accrued at the end of 2018, the possibility that markets might enter a period of higher volatility and overall steady decline is on everyone’s mind.

One of the biggest challenges for any investor is dealing with bear markets, and deciding what to do with his/her money when nothing seems to be going up.

The easy answer would be to simply not. Simply, stop investing and wait for the market to turn. But we all know this is not realistic or practical.

To begin with, how would you even know when the market is going to becoming bullish again? If you decide to stop investing because you think your investments might go down, then you shouldn’t be investing in the first place.

Investing is a risky business. Being a good investor means mitigating this risk while still achieving the most profit possible, and this is what we are going to be looking at today.

Even when the economy is bad,  one can make investments that either don’t suffer as much as others in downturns or even profit from recessions and crisis.

In this article, we are going to look at such options and suggest some ways for you to protect your money in times of uncertainty

What is a Bear Market?

Before you plan for a bear market, it is important to understand its nature. Most investors have a basic understanding of the term but what is the definition of bear market and how long does it last?

A bear market can be defined as an extended period of time during which investment security prices are generally declining. Most commonly, the term bear market describes a negative environment for stocks but the term can also refer to other investment securities, such as bonds or commodities.

The length of time that the period of generally declining prices lasts is called the duration. Historically bear market durations have ranged from approximately three months up to more than three years. Most bear market durations are longer than one year but less than two years.

Rebalancing your Portfolio

Investing proficiently means being able to adapt to changes in circumstances. To do this, you have to rebalance your portfolio.

This doesn’t mean actually changing the assets in your portfolio, but simply changing the weight of each of them. In other words, changing the percentage of that asset in your portfolio.

In a bear market, you would probably want to take a more “defensive” approach. This would mean maybe reducing your investments in stocks and shares and increasing bond holdings and even cash.

On the other hand, there is another option to rebalancing your portfolio. You could simply invest in assets that resist bad economies well or even thrive during hard times. The next few assets belong to these categories.

Diversify Your Investment Portfolio

Read: How to Diversify Your Portfolio

Counter-Cyclical

A counter-cyclical stock is a type of stock in which the underlying company belongs to an industry or niche with financial performance that is negatively correlated to the overall state of the economy. As a result, the stock’s price will also tend to move in a direction that is opposite to the general economic trend, meaning appreciation occurs during times of recession and depreciation in value occur in times of economic expansion.

Outplacement agency stocks, for example, would be considered counter-cyclical, because these companies help laid-off workers find jobs in exchange for a fee. This type of company would be more successful during times of recession because there would be more unemployed workers at that point in time compared to times of expansion. Purchasing counter-cyclical stocks can serve as a good hedge to the standard recessionary pressures that can cause most stocks to decline.

Counter-cyclical stocks may also include affordable retail companies and even producers of alcoholic beverages.

In the U.K, you could consider Tesco’s or TJ Maxx, amongst many others.

Blue-Chip Stocks

There is no official definition for a blue chip stock, but in general, they are large, stable, and financially sound companies that are leaders in their respective industries. These companies are often household names, have long track records of dependable earnings, and dominate their industry with a large market share. As a result of their fundamental strength, blue chip stocks are also popular stocks to buy.

While blue-chip stocks may not be growing as fast as the hottest start up coming out of Silicon Valley, their stability and staying power is an attractive draw for investors of all stripes.

These companies have often led their industries for decades, if not longer. They’ve thrived in boom times and emerged stronger from the tough times. Their products are recognized and valued by the customers they serve.

Stock Picks

Read: Blue Chip Stocks

The advantages of being a blue chip stock are also reflected in their financial statements. Blue chips often have better profit margins than their competitors, a result of strong branding, pricing power, and economies of scale. Their balance sheets are usually gigantic and well-managed as well, giving them access to low-cost capital from the bond market and other sources.

Blue chip stocks are usually included on the most popular stock indices, like the Dow Jones Industrial Average.

While these may not necessarily thrive during a recession, a lot of these companies are what we might call recession proof.

Companies with huge market share and consumer staples are unlikely to tank, even when the economy is bad.

Coca-cola could be an example of such a stock.

Cash and Money Markets

For the average investor, a decline in the markets that lasts more than a few months is enough of a catalyst to move out of an equities-heavy portfolio.The most common place to set aside funds from that sell-off is a cash or money market account. A cash account, most commonly in the form of a bank or credit union savings account, is not tied to the stock market and as such, presents little risk to investors.

A money market account, either offered through a bank as a deposit account or through a brokerage platform as a mutual fund, is also a common holding place for funds recently removed from the grip of the stock market.

Both savings and money market accounts provide investors a medium to earn interest without the risk of market fluctuations. Money held in cash or money market accounts can easily be invested back in the markets once the investor feels comfortable enough with performance.

Gold

Gold has always been looked at as the ultimate hedge against recessions, depressions and inflation. When everything else is failing, gold can be seen as a safe haven for investors.

It’s hard to know exactly what makes gold so attractive in times of hardship but there are a few characteristics that we can point out that make gold a good “investment”.

First of all, gold is rare. In fact, 98% of the gold in existence has already been mined. This means gold doesn’t act the same way other goods do. You can’t increase the supply of gold, even if the price goes up, which means when demand for gold increases, there’s no actual mechanism to stop the price from increasing

Investing in Gold

Read: Investing in Gold

Secondly, you would think that gold would not appreciate in a crisis since it actually has no utility, but history has proven this point wrong again and again. In times of hardship, people look at ways to store value because of uncertainty.

Gold is a timeless store of value. It can be exchanged anywhere and anytime for actual goods.

Currencies, on the other hand, can be unreliable. They change in value and they can suffer together with the economy. This is why people prefer to hold actual goods at such times

Go Short

Short selling stocks is a strategy to use when you expect a security’s price will decline. The traditional way to profit from stock trading is to “buy low and sell high”, but you do it in reverse order when you wish to sell short. To sell short, you sell shares of a security that you do not own, which you borrow from a broker. After you short a position via a short-sale, you eventually need to buy-to-cover to close the position, which means you buy back the shares later and return those shares to the broker from whom you borrowed the shares. You can make a profit from short selling if you buy back the shares at a lower price.

When you trade stocks in the traditional way (“buy low and sell high”), the maximum amount that you can lose is your initial investment. However, when short selling stocks, your losses are theoretically unlimited, since the higher the stock price goes, the more you could lose. You will be charged interest only on the shares you borrow, and you can short the shares as long as you meet the minimum margin requirement for the security.

In a bear market you could certainly short some of the more unstable emerging markets, or even some high yielding bonds.

There are plenty of ways of doing this such as using ETFs or options.

Conclusion

These are just some of many strategies you can take to adjust your investing strategy in order to make the best of a bad situation.

We could divide them into the more defensive strategies, such as buying bonds or gold and the more aggressive strategies, such as shorting the market or investing in counter-cyclical stocks.

Having said this, there are also two more important factors to keep in mind.

Firstly, remember that periods of corrections can be used to buy undervalued stock. Personally, I recommend keeping a decent amount of cash around so you can take advantage of falling prices. This is particularly good if you are using a value investing method.

Secondly, keep in mind that sometimes the best course of action, is inaction. All I am saying with this is basically, don’t panic.

I’ve said this many times before, but I’ll say it again. I am a big believer in the power of riding out the storm. In the long-run you will win. You will only lose if you panic and start selling cheap.

I hope you found this article useful.

James Foord

Based in Barcelona - Spain, James is an Economics Graduate and Financial Advisor offering advice on Pension Plans, Insurance & Mortgages. He has been writing about economics and investments for 7 years. james@moneycheck.com


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