A bear market can be a scary time for investors. The stock market seems to be falling every day, and it can be difficult to know what to do. In this blog post, we will discuss some tips for investing during a bear market. We will cover topics such as diversifying your portfolio and hedging your bets. We will also provide information on how to protect your investments from downside risk. Stay tuned for our latest tips!
What is a bear market and why should you care?
A bear market is a prolonged period of decline in the stock market. It is typically defined as a decline of 20% or more from the previous high, although draws parallels to a recession, which is two negative quarters of economic growth. Bear markets can occur for many reasons, such as an economic recession or a major political event. The market waxes and wanes, and so it is natural that following periods of strong performance, there will be periods where the opposite occurs. As a long-term investor, it's your job to weather this volatility in order to make the most of long term compounding. However, this can be difficult: it can be hard, especially for newer investors, to see the values of their holdings plummet and not take action, let alone think about investing during a bear market.
First things first: don't panic
Ok so the first step is to do absolutely nothing. It might be instinctive to try and sell up as panic sets in, but the most important thing is to avoid making irrational costly decisions. As a whole, the market will bounce back (if it does go down the pan completely, the stock market will be the least of your concern by that point). You wouldn't buy anything else high and sell it low, so why are stocks any different? Accepting that you are playing a long term game, and zooming out to think about multi decade market performance will make this easier. This can also be the justification for investing during a bear market, as you will now see.
Buying the dip
Now we've agreed that you won't be selling up, you can think about attractive buying propositions. Given that the market will likely be oversold as sentiment plummets, it can be a great time to hunt for bargains. Look for cash flow positive businesses with strong fundamentals that have been dragged down with the rest. If you're hell-bent on tech stocks, FAANG (Facebook, Amazon, Apple, Netflix, Google) and the like can be a good bet. If not, defensive consumer and manufacturing companies are also oversold. You have to be prepared for these to fall further after purchasing, which requires a strong resolve (and maybe a strong drink too), but after a few market cycles this will become second nature. Hard to catch a falling knife!
In general, it's more shrewd to avoid stock-picking altogether when investing during a bear market, and more generally, and one way of doing this effectively is something we've talked about before: dollar, or pound cost averaging. This involves investing a fixed sum of cash into a security or securities at regular intervals, regardless of the price. The goal here is to reduce the effects that sporadic changes, unrelated to the underlying security, might have on your investment. When done correctly, this should lower your average cost per share, which is the hope when investing in a bear market. Essentially, by investing say £1,000 per month, you're buying more when prices fall (and your £1,000 stretches further) and less when the reverse happens. It's a tried and tested method that removes autonomy from the process, and lets you get on with the business of, you know, your life.
How to diversify your portfolio
Another strategy that can be employed when investing during a bear market is to diversify your portfolio. This means investing in different asset classes and sectors in order to spread out your risk. For example, you might invest in stocks, bonds, and real estate. This will help to protect your portfolio from downside risk. By the time the recession comes round, it's probably a little late to do this but you can start collecting assets when they're on discount and securing your portfolio for the long term. There are various iterations of portfolio allocations depending on which school of thought you subscribe to, but each can be tracked with the Strabo portfolio tracking feature, allowing you to monitor performance and rebalance accordingly. Simply sign up at the foot of the page to learn more!
How to hedge your bets
A third investing strategy that can be used during a bear market is hedging your bets. This means investing in securities that are not correlated with the stock market. For example, you might invest in gold or commodities. This will help to protect your portfolio from downside risk. Historically, this has been a reasonable bet although it must be noted that performance of these types of "hard" alternatives have begun to slow down in recent years with the democratisation of markets and influx of new asset classes. One of the promises of cryptocurrency, particularly Bitcoin, was that it would be countercyclical to market cycles and therefore be a good hedge to stock market performance. However, recent years have shown almost the direct opposite to be true. The major crypto coins have been almost perfectly correlated with tech stocks and should be classified as speculative tech investments (for now, at least), rather than "digital gold." You can read more about our plan for crypto bear markets specifically here.
No assets are immune from sentiment, and so it would be foolish to expect that you will never see fluctuations.
Investing during a bear market can be difficult, but it is important to remember that you are playing the long game. There are a number of things you can do to protect your portfolio, such as diversifying your holdings and hedging your bets. The most important thing is to avoid making irrational decisions based on fear.
Buying for the long term eliminates the risk of short term volatility, but it's not all plain sailing. Remember that some stocks may never again see all time highs. It can be easy to look at the wider growth of the market and assume that everything will always go higher, but that is often not the case - survivorship bias means that we disproportionately read about successes in public markets. Even if they do make progress, it can often take much longer and see further declines first, as was the case with prominent examples like Amazon & Nvidia.
Again, more reason to keep an emergency fund (read more on that here) to allow you to weather these kinds of storms. Along with a robust portfolio allocation that matches both your appetite and capacity for risk, you will be able to survive, and perhaps even see the value in market corrections.