You may have heard that “we are in a bear market.” It is essential to know what that means and understand the implications for your investments. Should you just hang on? How to invest during a bear market? Are there moves you should be making? What are professional investors doing?
What Is a Bear Market?
“Bear market” means an index has dropped 20% from its most recent high. The term is sometimes used for individual stock, cryptocurrencies, gold, and other investments, but generally, it means that the broad market is dropping.
The average bear market sees a 36% drop in stock prices and lasts 9.6 months. Bear markets occur regularly: there have been 14 since World War 2, or one every 5.4 years on average. Every time, stocks have subsequently risen again.
Because bear markets have always been followed by upward cycles, experienced investors tend to see them as buying opportunities.
It is important to realize that the 20% drop indicates the beginning of an official bear market. It does not mean the bear market is over. Stock prices could drop lower.
Make a Plan
The most crucial action is to make a plan. Don’t simply react to what the market may do. Use the below suggestions to create a strategy that appeals to you, and execute it. Look at it this way: the market is going to have some surprises after a bear market begins. Don’t sit helplessly. There are things you can prepare for, from a market rebound to a market collapse. Know your strategies for either of those occurrences.
Ideas for Investing During a Bear Market
Your plan must be customized for your needs. Here are some ideas to use in putting together your strategy:
By the time you know there is a bear market, you have already lost 20% on average. The problem is that it could drop more. You could watch your stocks continue to decline in value.
Remember, though it is common to say, “I’ve lost money” when you see your investment account decrease in value. But you haven’t lost money unless you sell it. Think carefully about selling
The decision of whether to sell depends on your time horizon.
Short Time Horizon
Selling could preserve your cash if you are near retirement or are planning on using your investment money in the next year. This is especially true if you have held your investments a long time and have plenty of profits.
You will miss out on any price rebound, so this is a big step to take. Getting completely out and then getting entirely back in seldom works well. You miss out or fail to time the market accurately.
Long Time Horizon
What goes down comes up. If you have a five to 10-year period before you need the money, the chances are that the market will rebound.
In the history of the stock market, prices have recovered from a bear market every single time. Unless you think the market is going to zero and the world is going out of business permanently, the odds are in your favor that there will be a rebound from a bear market. It would be reasonable to hold on to your investments if you have the time for them to recover.
2. Sell Partial Positions
Instead of selling everything or keeping everything, think about selling only some of your assets. You can leave money in the market so you will take advantage of a rebound.
One approach is to leave the original investment amount in and just take the profits. You seldom go wrong taking profits.
The remainder will go down in value, but it will most likely rebound at some point. Then you will have additional profits.
3. Use Tax-Loss Harvesting
You can pick which stocks to sell by doing tax-loss harvesting. If the price drops below where you bought the stock, you can sell for a loss, which will be a deduction on your taxes. You can offset up to $3,000 dollars of your regular income by applying stock losses against it. And beyond the $3,000, you can carry your losses forward to the next tax year.
Tip: If you sell a stock for a loss and then immediately buy it back you can’t take a tax deduction on the loss. This is called the “wash-sale rule.” The IRS considers it a gimmick to get the tax write-off while essentially keeping the stock.
4. Rebalance Your Portfolio
If you decide to sell some stocks, you may want to rebalance your portfolio. This involves using the proceeds from your sales to buy stocks in other sectors. For example, you may want to buy stocks in technology, consumer goods, oil, and so forth.
A bear market is a good time to rebalance because it is likely that at least some of the new sectors you buy will go up in value. The prices should be good in these sectors because all stocks are down, so your rebalancing is likely to be effective.
You can also rebalance by investing in non-stock assets, such as real estate, gold, and cryptocurrency. A broader range of investments will position you for gains on many fronts.
The reason to rebalance in a bear market is that you can get tax write-offs on your losers and pocket profits on your winners.
5. Buy Dividend Stocks
If the economy goes into recession, stocks may not rise in value for a long time. You can buy stocks that pay dividends. These stocks pay shareholders quarterly out of company profits. You receive a deposit in your bank account for each share of dividend stock you own. However, you can elect to have your dividends reinvested so that you automatically buy more of the stock with your dividends.
In this way, you can achieve growth even if the stock itself does not go up in price. Dividend stocks are also less likely to fall significantly in value, because dividend yields rise as the stock’s price falls, drawing in new investors.
Warning: A bear market is not a recession. “Bear market” refers to stocks going down in price; “recession refers to businesses earning less. Often, a bear market may occur well before a recession because investors anticipate the coming contraction of the overall economy.
6. Use Dollar-Cost Averaging
When stocks are down in price, it can be an excellent time to buy. Some like to say, “stocks are on sale.” But how do you know stocks have gone as low as they are going to go?
The answer is you don’t. Even professional investors have trouble calling a bottom in stock prices.
You can get around this by using dollar-cost averaging. This means you buy a stock at regular intervals, such as every week or every month. You put the same exact dollar amount into the stock each time. So, let’s say you put in $1000 each time. That $1000 buys more shares if the price is down, but it buys fewer shares if the price is up. So your average share price is typically low.
Here is an example:
|Total: $5000||Average: $106 per share|
In the example, you see that though you paid as much as $150 per share during one purchase, the average price per share was only $106.
This way, you don’t have to guess the exact bottom. If share prices go down, you simply get more shares for your money and the average price remains low.
7. Buy Bonds
If you think stocks are not going to do well, you can buy bonds. Bonds pay you interest. You can invest that interest in more bonds or a money market account.
The bonds themselves may rise in value if interest rates start dropping–the attractive rate of return will be better than the new lower interest rates. That means buyers may want to purchase them from you.
Be aware, however, that the opposite is also true. If interest rates rise, your bond may decrease in value because it has a set interest rate and buyers can get a higher rate elsewhere. This won’t matter if you don’t plan to sell the bond.
8. Buy Growth Stocks
This is a contrarian approach, but if you have the time horizon and the risk tolerance it can be a very profitable strategy.
Bear markets tend to hit growth stocks the hardest. These stocks fly high during upward market cycles and often become overvalued. When the bear comes around investors bail and these stocks are often driven down to very low prices.
If you can put in the time and the research to find high-quality growth stocks that have what it takes to survive the downturn, you may be able to acquire these companies at a bargain price. When the next growth cycle comes around you may reap the rewards.
9. Put Money in a Money Market Account
You can earn interest in a money market account. This will pay more than a savings account, and you will make money even if stocks don’t rise. This is not a particularly high rate of return, but it is a relatively safe place to earn while you wait for the markets to cool off.
Warning: Money Market Accounts are not insured like savings accounts are. That said, they seldom lose money.
Respect the Bear, but Don’t Fear the Bear
A bear market can be scary. Stock prices plummet and investor portfolios shrink. Many investors panic and bail out, often taking significant losses in the process.
A bear market has to be taken seriously. Serious losses are possible. It’s still not a time to panic. Bear markets bring opportunity, and with the knowledge of how to invest during a bear market and the right strategy you can beat the bear and come out ahead.
The post 9 Bear Market Stock Tips: How to Invest During a Bear Market appeared first on FinMasters.