Whether you’re new or a veteran to the stock market, it is not pleasant to see your portfolio turn red. It is easy to get emotional when stocks are falling in price and it seems like there is no slowdown in sight. When you’re emotional, you’re less inclined to think rationally and that ends up causing you to make decisions that you will regret. To make the best of a bear market, you’ll need to remain level-headed. Easier said than done — I know.
So, for this post, I want to share 6 ways how I navigate a bear market to come out ahead when it is all over.
Disclaimer: I’m not a financial professional and what is mentioned in this post should not be considered as financial advice. Always do your own due diligence when it comes to your own money.
1. Build up a Cash Cushion
A bear market is tough for everyone including big corporations. Companies will be bringing in less revenue and might even start burning capital depending on how long a bear market lasts. During tough times like a bear market is when layoffs and unemployment starts to spike. So, it becomes extremely important for you to build a cash cushion of roughly 6 months of your essential expenses. Ideally, you should already have a cash cushion ready, but if you don’t, now is definitely the time to do so.
As to where you can put your cash for an emergency, it is best to put it somewhere safe and accessible like a high-yield savings account. Make sure the bank that you choose is FDIC insured, which guarantees up to $250,000 of your capital should anything happen with the bank. The amount protected may change in the future, but as of right now it is $250,000. As a side note, don’t get too caught up in the interest rate and instead focus on finding one that is reliable because the rates will always change depending on what the Feds do. For example, as of this post, the Feds have lowered interest rate to almost 0, which means many high-yield savings account have a rate of around 0.3% while they were around 1.3% a few weeks ago.
2. Don’t Invest Money You Need Right Now
Good investing opportunities will show up in a bear market, but you have to take care of yourself right now before thinking about your future self. So, don’t invest money you need to pay your bills thinking that the market will bounce back up quickly or you will get your next paycheck. Don’t fall into the situation where you put money into stock only to see it go lower in value and you need that money to pay for your living expenses. Put the money you need somewhere safe and if there is any money leftover invest it. This rule applies in general when you invest, but it really becomes crucial in a bear market.
3. Understand That You Didn’t Lose Any Money Until You Sell
It can hurt to look at your investment portfolio and see it fell down by a third of what it used to be and think to yourself that you just “lost” a third of your money. However, that is not the case because it is the paper value of your portfolio that has gone down. You didn’t actually lose any money until you make the decision to sell.
Where beginning investors make the mistake is that they take the paper value of their portfolio to face value and already consider they have lost that amount of money. They don’t consider the fact that once the bear market is over, the paper value of their portfolio can go back up even higher than before the drop. They get so fixated with the short-term that they end up selling out so they won’t lose more money. Sadly, by selling, they have locked in those losses with no chance for recovery. So, don’t sell your portfolio fearing that it can go down more because none of it matters until you sell.
The 5-day price for the Dow Jones in March 2020
Imagine if you sold your portfolio during the time when the Dow Jones was going from 21,000 to 19,000. Then see the price recover the following day from 19,000 to 20,0000. How would you feel then? You would probably regret selling out and wished you had held on.
4. Understand the Long-Term Trend of the Stock Market Is Up
If you look at the S&P 500 index, which tracks the 500 largest US companies, you’ll notice that the natural direction of the price is upward in the long-term. Although there are times when it was down (bear market), the market eventually recovered and prices soared higher than ever before. This has happened many times in the past, so what do you think is most likely to happen during another bear market?
The S&P 500 Index from 1930 to 2020. The area in grey indicates a bear market.
5. Dollar-Cost Average Into the Stock Market
One of the most common mistakes that beginning investors make is that they think they can time the market. Their strategy for a bear market is that they’ll get in at the bottom. Although that sounds great in theory, identifying the bottom is impossible. How can you know what was the bottom during a bear market? You let the bear market be over then you can tell what was the bottom. At that point, you have missed all the discounted prices of stocks.
So, instead of timing the market the next best thing you can do is use a technique call dollar-cost averaging (DCA). Dollar-cost averaging is when you break up the amount of capital you have for investing to smaller portions and invest that smaller portion on a repeated schedule until you run out of capital to invest. For example, you have $1,000 to invest. Instead of investing it all at once, you split it into $250 portion per week. So, every week you will invest $250 until you invested all $1,000.
Why does this work you might ask? Well, it’s because you’ll catch stocks on red days and green days so eventually it’ll average out to a price somewhere in between, which yields a good return and most importantly keep you in the market instead of the sidelines. In an extremely volatile market, dollar-cost averaging is the simplest way to take part in the stock market without stressing yourself about buying at the correct time.
6. Identify and Buy Into Companies That Has Survived Bad Times in the Past
In a bear market, you want to invest in companies that will come out of it alive. Newer companies (growth) don’t have a long record, so there is no proof that they can survive. So, that’s why you want to go on a treasure hunt to find yourself a few companies that have been around for a long time and have survived a few bear markets. It will lower the risk of investing if you only target strong companies that have survived through tough times. If picking individual stocks is not your thing then you can always stick with dollar-cost averaging into a market index such as the S&P 500.
I hope this post was helpful to you. If you found this post helpful, share it with others so they can benefit too.
Have you experienced a bear market before? What did you do during the bear market?
To get in touch, follow me on Twitter, leave a comment, or send me an email at steven@brightdevelopers.com.