Let's play a game. You're walking through the woods and suddenly a huge grizzly bear steps into your path. When the bear sees you, it gnashes its long teeth and raises its razor-sharp claws. Then it lets out a deafening roar and charges. What do you do?
Believe it or not, one way to survive a bear attack is to play dead. If the bear thinks you're dead, it won't think of you as a threat and will likely leave you alone. The same survival tactic can be just as effective when investing in a bear market. According to reports on an internal study by Fidelity, the accounts that performed best from 2003 to 2013, which includes the 2008 financial crisis, were owned by investors who forgot they had an account – or were dead!
For some investors, when the market takes a turn for the worse, the best action may be no action at all. The goal is to stay calm, and peace of mind can come from knowing what to do. Here are some investing tips for a bear market.
What is a Bear Market?
The technical definition of a bear market is a decline of 20 percent or more from the market's previous peak. Share prices for most of the stocks in the market will drop by the same amount or more. These types of downturns don't happen a lot, but they are far from uncommon. On average, a bear market has occurred once every 3.5 years. Since World War II, the average bear market has lasted 14 months. In comparison, the average bull market lasts 4.5 years.
Still, that doesn't mean bear markets aren't painful. During each bear market since the 1940s, the S&P 500 index has fallen by an average of 33 percent. Investors, however, are not helpless. There are a variety of strategies investors can follow to help them through a bear market. The right strategy depends on personal factors, including the investor's financial goals, investment targets, and tolerance for risk.
Strategy: Overcome Bear Investment Challenges
As a bear market occurs, one strategy is to essentially run for the exits. That is, sell all your stocks and place the money in a cash account, or buy low-risk investments like short-term government bonds. The major perks and bonuses of a savings or money market account is investors get some interest and no exposure to market losses. Short-term debt securities, such as U.S. Treasuries, are relatively uncorrelated to stocks, meaning their prices rise when stock prices fall.
The goal is to weather the market storm and mitigate your losses, but, just like it's difficult to outrun a bear, it's difficult to time the market accurately. To effectively execute this strategy, you must sell and buy back in at the right time, or you risk missing out on the gains that come with a market rebound.
Another strategy is to remain in the stock market but invest in what are considered defensive stocks. These are large, healthy companies that have strong histories. These include companies in generally secure industries such as food services and healthcare. Long-established companies with stable track records are more likely to stay afloat during a market downturn than smaller, riskier companies. Further, defensive stock prices typically remain stable during bear markets. That makes this a strategy for investors who would prefer to stay invested in the stock market.
The key to any bear market strategy is to implement it at the right time. When a bear market officially hits, it may too late. The right strategy can help limit the damage, but investors shouldn't expect to get through completely unscathed.
How to Invest in a Bear Market
One thing to keep in mind during a bear market is that the market has historically always recovered. That can help investors stay committed when times get rough, but it doesn't necessarily provide much guidance as to how to invest during a downturn.
If you have cash you would like to invest in the market, one option is to spread out your investment purchases over time instead of investing it all at once. This is called dollar-cost averaging. It is an alternative to trying to guess when stocks have hit bottom. If stocks continue their downward trajectory, you can continue to buy at even cheaper prices.
Avoiding steep losses during a bear market is all about risk. The more risk you have in your portfolio, the greater the potential for losses. A strategy for reducing risk is diversifying your investments. That means holding a broad mix of assets, such as stocks, bonds, and cash, in your portfolio. Diversification reduces your exposure to one particular asset or assets that rise and fall together. Instead, you get mix of wins and losses, which helps generate steadier returns.
As previously mentioned, you may want to move funds to assets that produce relatively consistent returns. Again, these are companies in industries that do well irrespective of what goes on in the market or economy (healthcare, food, etc.). Another option is to buy stocks that pay high dividends, even during bear markets. This may be most attractive to retired investors who are making withdrawals and spending cash from their portfolio for living expenses.
Investors who can't risk a dramatic loss, such as those about to retire, and want to take a break from the market still need to have a clear short-term strategy. Some of the places an investor could put those funds are in a certificate of deposit, high-yield savings account, money market account or peer-to-peer lending. However, the typical return on these savings vehicles is around 3%, which is just about even to the historical rate of inflation. Therefore, it is important consider these options only for the short term.
Patience is a Virtue
Ultimately, investors should exercise patience during a bear market. Those saving in a retirement account should continue to do so. The ideal amount to save for retirement is around 15% of your paycheck. That should never change until you retire. Instead, stay the course so you are in position to capture the upside of the eventual rebound. In other words, turn off the news, and don't obsessively check your account.
If you're a long-term investor, you can expect to experience a bear market or two. Knowing that, you can prepare choose an appropriate strategy for when the time comes. That may be to shift to defensive positions or simply do nothing at all. The most important thing is to avoid making a mistake that will just make matters worse.