Portfolio Protection Strategies to Be Successful in Bear Markets
A peak to trough drop of 20% or more in US large cap stocks is referred to as the bear market. This is a time when the prices of securities drastically fall. Although it is hard to predict a bear market and how long it can last, the 2020 bear market can be easily linked to the Coronavirus. Most investors tend to panic in such a situation. However, the following strategies can help them protect their portfolios even in a bear market.
Do not sell stocks
A common mistake that most investors follow is to sell their shares as soon as they see their prices falling. This brings in nothing but losses. Stocks should indeed form a significant part of a portfolio. The bear market may seem volatile, but keeping stocks intact will give individuals the opportunity to rise in the market after a downturn.
Invest in puts
Put options allow the investor to sell the stock at a fixed price within a given frame of time. If the price of the stock falls below the strike price, the investor can sell these stocks back to the seller for a predetermined price. However, put options have an expiration date, and the re-selling should be accommodated before the expiration date. Put options can help individuals override the losses in the market. They give investors the option to sell their shares at a comparatively better price. Investing in short term and long term puts can be a great strategy to protect a portfolio against market downturns but needs thorough understanding, knowledge, experience.
Include more cash investments
Cash investments can significantly reduce risk in a portfolio. These investments are unaffected by the volatility in the market and offer investors the chance to take advantage of the changing market conditions. Investors should aim at contributing the money from tax refunds, returns from selling personal assets, etc. to their cash reserves. Not all the money that one earns from their portfolio should be reinvested in stocks, some of it should also be contributed to cash investments.
Sell naked puts
In a naked put, the investor sells the put without owning or having a position in the stock. Investors usually sell put options keeping in mind that the put will expire above its strike price or be worthless. If this happens, they get to profit from the premium. A put option can be sold by investors in return for cash in a bear market, and the premium can offer the portfolio the necessary protection in a downturn. Selling short term puts on well established companies can be a good strategy to follow.
Look for stocks that can survive a bear market
Sometimes stocks like real estate, gold, and other precious metals remain unaffected by bear markets. Even in the Coronavirus pandemic, the one sector that has not been negatively hit by falling prices is the food sector. Stocks of personal care and hygiene products, gold, food, etc., have also performed well in bear markets in the past. It is helpful to do a past market analysis to see how stocks of different commodities react to bear markets. Investors can review company performances published by financial websites to see how each sector is performing. This will help individuals make better investment decisions. Another vital thing to note here is that sectors that do well in bear markets tend to perform well for a significant amount of time, bringing in good returns and some stability to the portfolio.
Diversify your portfolio
Diversification as a strategy is applicable to all cycles of a market, but it becomes even more essential in a bear market. The stocks of a single country or company are likely to perform in the same manner. However, a well diversified portfolio with equal allotment to several sectors, countries, and companies is expected to override the change in the market. Different sectors and economies react to the market differently. Investors should take advantage of this phenomenon to protect themselves from risk.
Look outside the portfolio as well
The last two stock market falls to hit the world were the Great Recession and the dot com bust. Both these incidents taught the world that a falling stock market is usually the outcome of a weak economy. When the prices of stocks show a continued decline, the economy suffers too. This is where recessions eventually sets in. Recession can further give rise to a number of problems like unemployment, pay cuts, low profits, etc. One of the most effective strategies to be prepared in such a scenario is to have liquid cash outside the portfolio. Liquid cash can offer people the necessary financial cushion in a suffering economy and market.
Simple strategies like reducing avoidable expenses and lowering the over cost of living can help people build their cash corpus. This is also a time when people should reduce their debt. Instead of steering into recession with a hefty load of debt, investors should focus on eliminating debt at the first onset of market downfalls.
To sum it up
A bear market can seem frightening, but there are strategies that can help individuals protect their portfolios. Understanding and evaluating how various stocks performed in past episodes of bear markets can help investors gain more insight into how to keep a balanced portfolio. Diversification and cash reserves should be an investor’s top priority during these times.
If you need a professional opinion on how to protect your portfolio in a bear market, you can get in touch with financial advisors.