Bear markets present a challenge to even the savviest investors. Whether you have $1,000 in the market or $1 million, losing money hurts. It is during these declining markets that your patience will be tested. If fear sets in, you might consider bailing out on your investment plan completely—which can actually do more damage than anything else. Here's how to weather a bear market and drastic dips in the stock market.
Create the Right Investment Allocation
The key to making it through a bear market without losing sleep comes from the construction of your portfolio. Your portfolio probably consists of a number of mutual funds, ETFs, stocks, and bonds.
Together, this eclectic mix of investments is designed to achieve a certain goal. You may have a 401(k) plan to fund retirement or a 529 plan for your child’s education. Regardless, it's important to ensure your investments are doing what you intended.
If you took 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 you plan to use the money, and are an aggressive investor, you might be invested completely in stocks. But you should only invest 100% in stocks if you're comfortable with the fact that with significant gains also comes significant losses at times. That is just the nature of investing entirely in stocks, so it's important to know your risk tolerance.
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 investing according to your risk tolerance. This commonly happens when investors get overly aggressive in a bull market but turn conservative once losses start showing up on statements. Avoid the temptation to alter your investments based on what the prevailing markets are doing and stick to a strategy that works for your risk tolerance and timeline.
Use Dollar Cost Averaging
Dollar cost averaging is a technique used by many investors taking part in their employer-sponsored retirement plan. A fixed dollar amount is taken out of each paycheck weekly, bi-weekly, or monthly, and added to an investment account. Since the same amount is invested on a regular basis, you’re making investment purchases when prices are high, low, and everywhere in-between.
For the average investor, when the market is down, you’ll be buying more shares with that money. The more shares you have, the greater the value increase when the market recovers. You can think of a bear market as a sale at your favorite store. When the items go down in price, you can buy more with the same amount of money as when they're full price.
Consider Inverse ETFs and Defensive Stocks
If you're a more advanced investor and ready to take things one step further, you could invest in inverse ETFs or mutual funds that are designed to go up when the market goes down. These investments could hedge against the losses elsewhere in your portfolio.
Inverse investment products aim to perform the opposite of the underlying market. It works both ways, too, so if stocks go up, these funds go down. Inverse ETFs are 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.
Another option could be investing in defensive stocks. These aren't stocks of companies in the defense sector. Instead, they refer to 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.
The Bottom Line
Patient investors who coordinate their investing approach with their personal risk tolerance can weather a bear market. While losing money is never an easy pill to swallow, the best way to get through market dips is to do nothing and keep your long-term goals in mind. If you do want to hedge against losses, consider a diversified portfolio, dollar cost averaging, and inverse and defensive investment products. You may just be able to come out on top with your investments.