By Peter Mastrantuono
Bear markets are a natural and inevitable occurrence. The short, but deep bear market experienced last year is surely not the last one investors will endure.
Because no one can time the next bear market, predict how much it will fall or how long it will last, trying to time a coming bear market is fraught with danger. Chief among the risks of timing a bear market are missing out on gains by getting out of the market too soon and remaining on the sidelines and not participating in the recovery that follows.
There are, nevertheless, a number of actions you can take to mitigate the impact of the next bear market.
Unlike the recent pandemic-induced bear market that drove consumer staples and technology shares higher, the winners and losers in a rising rate landscape will be much different. A financial advisor can help you think through that and identify stocks that may be relative safe harbors or disproportionately affected. (Don’t limit your adjustments to your stock portfolio. Rising rates will cause bond prices to fall, so a rotation to shorter maturities, variable-rate or inflation-linked bonds may be appropriate.)
- Review Your Current Portfolio: Rising stock prices can move you away from your long-term strategic asset allocation target. For instance, if your goals and risk preference resulted in a portfolio comprised of 60% equities, higher stock prices may have had the effect of elevating your overall stock exposure, adding risk that you may not want. Trimming stock exposure and redeploying to other asset classes may help you to keep your portfolio in line with your risk profile and reduce a bear market’s impact.
- Consider Strategies to Protect Stock Positions and Generate Income: Protective put options can help limit downside risk, while writing covered calls can be a source for generating returns. Because these fairly conservative option strategies have a measure of complexity and nuance, you may find it valuable to work with an experienced financial advisor on implementing such a strategy.
- Increase Your Cash Position: No one ever went broke taking a profit. If you feel the market is topping, realizing your gains is smart and understandable. The added cash position will not only buffer your portfolio against the coming bear market decline, but it will also be the “dry powder” to buy good companies at attractive, temporarily-depressed prices.
- Evaluate Your Stock Holdings: Companies that are profitable, have strong balance sheets and enjoy significant competitive advantage are better positioned to withstand the challenges of a market swoon. Look to lighten up on financially weaker and more speculative companies.
- Understand the Catalyst for the Next Bear Market: What triggers the next bear market is no easy thing to discern, but it may pay to think about the possibilities. For instance, if inflation and rising interest rates, in your view, represent a strong potential catalyst for the next bear market, then that should inform your portfolio positioning.
The best defense, ultimately, may be a simple act of acceptance and faith. Once you accept that bear markets are an unavoidable part of the journey to long-term capital growth and you have faith that they will eventually end, bear markets become more, well, bearable.
Peter Mastrantuono is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Peter worked for over 30 years in the wealth management industry, focusing on retirement planning, investing, asset allocation and financial planning.