13 Advises for Bear Market Players

The idea of investing is to make your money grow, but there are times when the stock market doesn’t want cooperate. Regular market fluctuations are common and expected, but extended periods of decline can strike fear in even seasoned investors. These bear markets can last months or even years. So, what should you do when faced with a bear market?

1. Examine Your Investment Objective

The first thing anyone should do before making changes to their portfolio is to think about what the purpose of the investment is. Is it money for retirement? College savings? A down payment on a house? Each of these investment goals have to be treated differently, and you need take into account what the money is going to be used for before you can decide if any changes need to be made.

The investment objective is important because it primarily deals with a specific time horizon. If you’re 35 years old and saving for retirement, you know that your money has a few decades left to grow. On the other hand, if you’re 35 and preparing to send your child off to college in 8 years, that is a completely different scenario.

2. Consider Your Risk Tolerance

Most people make changes to their investments because of losses. When you begin to see your account drop in value, it’s only natural to want to stop this from happening. Unfortunately, this type of behavior is reactionary, and it can often do more harm than good.

If the idea of seeing a loss on your statement has you feeling uneasy and ready to make changes, then chances are you’re taking on more risk than you should be. You should be allocating your investments in a way that minimizes risk, maximizes returns, and allows you to sleep at night regardless of what the market is doing. If you’re losing sleep because of a few bad days in the market, it’s time to reconsider how much risk you’re willing to take.

3. Don’t Chase the Market

You’ve probably heard the saying “buy low and sell high” many times, and we all know that’s how you make money, but the reality is that most people do just the opposite. The average investor will happily put more and more money into the market, and take on more risk when the market and economy is strong, and pull back or stop investing at all when the markets are heading south.

This is the opposite of what you want to do. If you’re only saving and investing when the markets are doing well, and investing little or selling stocks when the markets are down, you’re buying high and selling low, which is a very ineffective way to make money.

If you have a regular investment plan through your 401(k) or individual retirement accounts, keep those investments flowing through good times and bad. Because you’re investing on a regular and frequent interval, you’re buying stocks when they are up, down, and everywhere in-between. This is called dollar-cost averaging, and it is a great way to take some of the volatility out of your portfolio and maximize your overall returns.

4. Rebalance Your Portfolio

When the markets experience an extended period of growth or decline, it can throw your portfolio out of its original investment mix, or asset allocation. For example, if you’ve determined that a 70% stock and 30% bond portfolio is suitable for you and the stock market has taken a bit of a dive, you might find that after just six months, your investment mix might be at 60% stocks and 40% bonds, or even a 50% mix.

Ideally, you want to maintain your portfolio so that it remains close to your target investment mix. By rebalancing to your target mix, you’re forced to sell some of the investments that have done well, and buy more of the investments that haven’t done as well. This is allowing you to buy low and sell high instead of the reverse.

4. Shore up Your Short-Term Investments

Investing your short-term savings takes a different approach from investing for retirement or other long-term goals. The general idea here is not to generate as much money as possible, but instead it is more focused on safety of principal while making as much money as possible.

When the economy is struggling, it pays to have a well-funded emergency fund. A weak economy can put some uncertainty in the air in terms of job security and obtaining credit. This is where your savings can come in handy. If you have the cash on hand in the event of an emergency, you don’t have to worry about using credit cards or possibly hurt your credit score.

So, when it comes to your savings, whether an emergency fund, money for a down payment on a house or a vehicle, or just the extra spending money you like to keep on hand, you want to make sure it’s safe and working as hard as it can for you. There are a number of places to safely keep your cash, so you’ll want to explore all the different options. It’s also a good idea to make sure your money is FDIC insured so that if times get really tough and your bank goes under, you’ll be protected.

5. Create the Right Investment Allocation

The key to making it through a bear market without losing sleep comes from the construction of your portfolio. You have probably have a portfolio that consists of a number of mutual funds, ETFs, stocks, and bonds. Together, this eclectic mix of investments is designed to achieve a certain goal. It may be part of a 401(k) plan to fund retirement or a 529 plan for your child’s education, but whatever its goal, you want to make sure your investments are doing what you intended.

If you have taken the time to create an investment mix that is suitable for your risk tolerance and investment objective, then a bear market shouldn’t concern you. For instance, if you have a few decades before needing the money, and are an aggressive investor, you might be invested completely in stocks. There is nothing wrong with that, but you should only be invested this way if you understand, and are comfortable with the fact that with significant gains may come significant losses at times. That is just the nature of investing entirely in stocks.

If you find yourself in a situation where you become uncomfortable with the losses in your portfolio, that is a sign that you probably aren’t invested according to your risk tolerance. This commonly happens when investors get overly aggressive in a bull market, and suddenly find themselves turning conservative once losses start to show up on statements. Avoid the temptation to alter your investments based on what the prevailing markets are doing.

6. Take Advantage of Dollar Cost Averaging

Dollar cost averaging is a technique utilized by most investors who take part in their employer-sponsored retirement plan. A fixed dollar amount is taken out of each paycheck weekly, bi-weekly, or monthly, and invested in. Since the same amount is invested on a regular basis, you’re making investment purchases when prices are high, low, and everywhere in-between.

This is an advantage to the average investor because it just means when the market is down, you’ll be buying more shares with that money. The more shares you have, the greater the increase in value when the market recovers. So, think of a bear market as a sale at your favorite store when you can buy things at a discount.

7. Profit From Falling Stocks

If you want to take things one step further, you may want to consider investing some money in ETFs or mutual funds that are designed to go up when the market goes down. These investments could then offset some of the losses elsewhere in your portfolio.

The problem is that since these investments try to do the opposite of what the underlying market does, if stocks start to go up again, these funds are going to go down. It is a double-edged sword, and trying to time the market with a strategy like this can introduce even more risk to your portfolio than you expected.

8. Consider Defensive Stocks

Defensive stocks don’t mean companies in the defense sector, but refer to generally larger companies that are better suited to withstand a prolonged bear market. Common traits for defensive stocks are companies with strong balance sheets that have been in business for a long time. Smaller and younger companies may not have the financial stability to weather a bear market, so you can minimize the impact of a declining market if you’re concentrated on larger and more stable companies.

9. Keep your eyes peeled

Tough times are great for highlighting both good and bad businesses. Good businesses will be less affected by downturns, or will be able to adapt their business models accordingly. Companies that can continue to invest heavily through slumps are often worthy of close attention. When the recovery eventually comes, they'll be a step ahead of their competitors.

Equally, cracks in shaky business models are quickly exposed by falls in economic activity. To be frank, we're probably too late on this one and much of the damage will have been done to the share price already. Still, it's a good educational process to see what's fallen the most. It could help you avoid a similar mistake when the next downturn arrives.

10. Be brutal

It's important not to get carried away by fancy forecasts about the potential of a business. Especially with smaller and younger companies, the rate of growth is difficult to predict and tends to be slower than brokers expect. Treat forecasts with even more disdain than usual during a downturn. Knock 10%, 20% or even 25% off the figures and consider whether you'd still buy or continue to hold any investment you examine.

I think it's also a good time to have a more concentrated portfolio. So consider selling out of what you think are the weakest companies you hold and invest the proceeds in those that you believe have the strongest prospects.

11. Delve into debt

When looking at an investment these days, the first thing to examine is its cash position. Has it been generating or losing cash over the last few years? What level of debt does it have and when do debts have to be repaid or refinanced? If you want to investigate a company's financial health in even more detail, consider using the Altman Z-score, a ratio designed to predict which companies may go bankrupt.

Many U.K. businesses currently have too much debt, in my opinion. There has been pressure from institutions in recent years for companies to gear up their balance sheets to expand more quickly or buy back their shares. In calmer times, these higher levels of debt are manageable. At the moment, they're not looking too comfortable.

12. Step back and switch off

As with all walks of life, there's a lot of nonsense written about the stock market and the economy. Sifting through the information that is both important and relevant to your investments is a skill that many people take years to learn.

We're flooded with bad news at the moment, as it makes for good headlines. Taking a step back from the furor of the financial press makes a lot of sense at times like this. It helps you ignore the short term, form your own opinions, and focus on the long term.

13. Don't get emotional

It's important to keep emotions out of investing as much as possible. When share prices are gyrating wildly, it's especially vital. We make rash decisions when we're emotional, focusing on recent and trivial information at the expense of the bigger picture.

So, if you find yourself swearing at your computer screen every time you look at your portfolio or, even worse, letting off steam by insulting company managements on bulletin boards, then I think you'd need to question whether you're cut out to be an investor. Management is there to look after the business, not the share price and, on occasions such as this, the smaller and more speculative companies that many private investors tend to favor get hit especially hard, regardless of the progress they're making.


Sources:

http://financialplan.about.com/od/personalfinance/a/BearInvesting.htm
http://financialplan.about.com/od/personalfinance/a/BearMarketTips.htm
http://www.fool.com/investing/international/2008/08/05/five-tips-for-beating-the-bear-market.aspx

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