How to survive a bear market

There’s a lot of talk and writing about the market being overvalued. It still appears fairly valued, especially when we look at the P/E levels over the next one and two years. But that doesn’t mean we won’t have a correction or bear market.

IS THE MARKET “OVERBOUGHT”?

Related to market valuation is whether the market is overbought or, in other words, too popular. If there’s a lot of cash flowing to an area, it can become too pricey. The S&P 500 is up 19.25 percent over the last five years.

Is there too much cash leaving low-yielding bank accounts, chasing the stock market? Maybe.  

This can result in a solid economy (and stock market) moving up too quickly. Then BAM! A market correction or bear can occur. This is like spring-cleaning for the markets. It has to happen sometimes.

Luckily, there are some ways to prepare for this eventuality.

LESSON FROM WARREN BUFFETT’S MENTOR

There’s a popular book called The Intelligent Investor. Ben Graham, who mentored the famous investor, wrote it. In the book, he covers just a few strategies that he feels actually works. The big one is asset allocation.

Asset allocation is simply owning many unique asset classes. This strategy can help when done correctly.

During “The Great Recession”, I had the majority of my clients in an asset allocation plan. Did their accounts drop in value? Unfortunately, yes. But, instead of dropping 50 percent, like the market did, the drops were smaller. Many were around 25 percent. So a hypothetical $100,000 dropped to $75,000. This is much easier to build from than a drop to $50,000 like the broad market.

Most importantly, we preserved value.

WHAT MOST GROWTH INVESTORS FORGET

Another way to prepare for a market drop is to invest for high income. Even growth investors deserve high income. Remember, we just had the first full decade in the stock market where $10,000 became $9,090.

What if that happens again? If your portfolio produces low income then you are forced to wait. If you produce double or triple the average income then you now have new money to invest when the market drops.

ANOTHER WAY TO PROTECT

Combining the first two ideas we have portfolio re-balancing. If you have a smart allocation with multiple assets this can work. For example, you may have asset categories that are up in value while others are down. You just sell the gains from the winners and now you have even more cash in addition to reinvest low.

If you had just one asset, let’s say an S&P 500 index fund, and it drops, you’re stuck waiting again. It would be better to have different “plays” working for you, potentially gaining.

BONUS METHOD

There are now many creative mutual funds that can protect against downward market moves. These can be very aggressive and should usually only be used on a short-term basis.

A few examples are the iPath S&P 500 VIX (symbol: VIX) and the ProShares Short S&P 500 fund (symbol: SH). The first can profit when there’s a lot of market volatility, tracking the VIX volatility index. The second attempts to short the S&P 500. This should go up when the market goes down.

Remember to use these sparingly, if at all. They might be a small, single-digit percent of your portfolio. But these can lose a lot of value if the market moves up. Be careful.

If you’re looking for an experienced, second opinion on your investments, please request my free report “How to Create Your Own Dynamic Income Portfolio.” Use the contact info below.