A Beginner’s Guide to Investing in a Bear Market
You can think of a bear market as being kind of similar to a tornado, they can be especially hard to prepare for, and can be destructive to those who are not prepared.
The market can officially be considered in a bear market when an index, such as the S&P 500, has a closing price that is 20 percent lower from the most recent high.
So how do you invest in a bear market and still make money?
There are several strategies to navigate a bear market and still generate returns. Keep reading to discover the beginner’s guide to investing in a bear market.
Plan for the Future
It may be hard to think about the future when you are looking at the market volatility, questioning whether to invest your money or wait until a better opportunity.
It may sound counter intuitive to suggest, but during a bear market is typically the best time to invest in the future. During a downtrend in the market, equity prices drop to levels they wouldn’t usually see when compared to a bull market.
This allows investors to invest in companies they believe will be worth more or generate more earnings than they do currently.
A great example of this is Apple stock. If you bought Apple during the bear market of ’07-’09, you could have invested for around 12$ a share. Let’s say you decided to purchase 200 shares for a price of $2,400.
Those same shares would be worth $63,600 today. That’s a 2,550% gain with Apple’s share price around $318.
That isn’t even factoring in the dividends you would receive and if you potentially reinvested them to compound your returns.
In other words, take advantage of the bargain prices of assets during a bear market because you don’t see equities priced that low all the time. This is a great time to plan for the future and determine what investments will be worth more when the market begins to turn.
Look For Deals
This leads me to the next strategy used by many seasoned investors to ride the waves of a bear market.
An indicator that has been used by investors for a very long time to find the value of a company is the PE ratio. The PE ratio is determined by putting the current share price of the asset over the earnings per share. Many investors use this formula to determine whether an asset is overvalued or undervalued.
The higher the PE ratio, the more overvalued the asset is considered. A high PE ratio could also mean that investors are expecting the company to grow at a fast rate.
While a low PE ratio could mean the company is undervalued, it could also mean business is risky, or it might even have a poor earnings outlook.
It is critical while investing in a bear market to do your due diligence on the stocks you are considering investing in as they can be especially vulnerable while the markets are volatile.
Another essential term to understand is the stocks beta. Beta is a measurement tool to determine a certain equities volatility when compared to the market. Looking at the beta of a stock is an excellent way of determining how risky the stock may be.
Stocks with a beta of less than zero move less than the market and are considered less risky. On the other hand, stocks with a higher beta are generally considered riskier because they move more than the market, but also have the potential for higher returns.
Diversify
I’m sure you have heard of the saying “don’t put all of your eggs in one basket,” and this is especially true when it comes to investing in a bear market.
The problem with putting all of your eggs in one basket during a bear market is the risk is much higher than during a bull market. One bad headline for the company you are invested in could wipe out your entire portfolio. This is especially true if you are investing on margin or borrowed money from the broker.
When it comes to diversification, you could go about it in many ways. You could potentially invest in index funds, which are mutual funds that track the overall performance of the market. Or you could develop your own investment plan that includes investing in a wide range of assets.
If you are planning on developing your own investment plan, you should include equities from at least a few different sectors to ensure your portfolio is protected during market declines.
Some investors prefer investing in negative beta stocks while the market is declining. Gold is a popular negative beta asset that typically moves the opposite of what the market is doing.
This is thought to be because, during bear markets, investors are looking for assets that don’t depreciate as much as others. Investors use gold as a hedge to protect their portfolios from the uncertainty of the market.
Image Credit: Flickr Creative Commons 2.0 – Investing in a Bear Market NASDAQDividends Are Your Friend
No matter what you are investing in a bull vs. bear market, you should include some dividend stocks to help compound returns and build up your portfolio.
A dividend is a portion of the profit that was generated by the company through earnings that is payable to its investors. Dividends are typically paid quarterly and vary depending on the business distributing them.
Dividends can add up throughout the years, especially if they are being reinvested back into the company.
In fact, since 1970, 78 percent of the returns from the S&P 500 have been from reinvesting dividends and taking advantage of compounding.
One way to find higher-paying dividend stocks is through the dividend yield, which is a ratio calculated by using the dividend per share divided by the current price per share. This will show you how much a particular company pays in dividends compared to the stock price of the asset.
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For More Advice on Investing in a Bear Market
Investing in a bear market does come with its risks, but if you know what to look for and take your time developing a plan, bear market investing can yield significant returns. For more financial advice and tips on investing, check out our website!