Value investor with a deep passion for understanding and a desire to improve results over time.
What to Do Before, During, and After a Bear Market
The sky is falling! You've invested steadily over the years, and now it seems like the market is punishing you, taking away everything you've worked so hard for. It's time to take a deep breath and remember that this is not the end of the world for your stock portfolio. It's also time to learn about how you can navigate before, during, and after a bear market when an index is down 20% or more from its all-time high.
Clearly, being prepared is the best method of avoiding or mitigating any type of crisis. Unfortunately, my own personal crystal ball has been in the repair shop since the dot com era, and I'm betting yours isn't working too well, either. This means we need to rely on a steady process of buying and selling that takes into account what our overall portfolio looks like.
Diversification and good portfolio management will help to ensure that you're ready for most crises, and while broad market selloffs affect nearly everyone, you can often find pockets of success here and there. If some of your stocks are doing well in a downturn, this can offset some much bigger "paper losses" (remember, you don't lose money unless you sell at a loss, but we all understand that looking at a sinking portfolio can feel like being punched in the gut). Even better, you might be able to sell some of the outperformers and use that cash to buy some of the higher quality names that are "on sale."
One final note on the "before" section: don't use any margin! Unless you're a professional investor, you probably have no business using a margin account to buy stocks, even (especially) during good times. Borrowing to buy, even during the best of times, can come back to haunt you during a crash, as you are now forced to sell at a loss in order to cover your margin account. No thanks!
You're probably here for this section. I get that. But please, please keep in mind that both the "before" and the "after" are just as important as "during" in the long run, so understanding the whole picture is really important. That said, there are some things you can do while the sky is falling in order to help yourself sleep better (no guarantees), or at least minimize some of the negative impacts.
Start by trying to set your own mind at ease. You know the statistics well by now: nearly everyone underperforms the market, and market timing makes this performance even worse. Individual investors tend to panic and sell at the worst times, when stocks are much lower.
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During a crash can be a fantastic time to find some amazing bargains. Generally, it's best to reach for higher quality names during a crash, not just whatever's "on sale" the most. You need to really take the time to think through whether a stock is a good bargain based on how it will do in the future, which means thinking about macro and fundamentals at a minimum. If you have "new money" coming in from your salary, a business, or another source of income, or if you've saved a bunch of cash, you're in a great position to start buying cautiously whenever things are going on sale. Keep in mind the falling knife concept, though.
If you don't have any cash coming in, and if you're fully invested in stocks without any cash reserves left, there are still ways you can use your portfolio to generate new money. My two current favorites are dividends (the ultimate passive income stream) and covered call options.
Building an entire portfolio around this concept might not be a good fit for you, but if you've already got more than 100 of a particular stock, you can start using this strategy to generate small amounts of income right away. In a declining market, a riskier strategy to generate cash right now would be to sell cash-secured puts (an explanation is a little outside of the scope of this article, but you can think of it as the inverse of the covered call).
The aftermath is just as important as what has come before. This is where you take off your investor hat and temporarily put on your historian hat. Conduct a post-mortem by taking a granular look at how your individual stock picks have performed during the crash. Did you sell at a really dumb time? Should you have been buying instead of selling as the market neared its bottom? Is there really any way you could have known where the bottom was? Spoiler: no.
Meanwhile, you need to rebalance your portfolio. Take a look at the repricing that has taken place. Some sectors are probably selling at much lower (or higher) multiples than they were before the bear market started. You need to take multiple expansion into account for future stock picks since your prior assumptions of fair value may not line up with what the market will do for the next several years. You might want to consider buying more of those repriced stocks just so you can be prepared for the next repricing in a few years, but you might also want to reconsider whether that's a good idea, given the sector itself.
Is it going to return with a vengeance one day, like real estate, or could it become antiquated, as the horse carriage businesses sector was during the early 20th century? Now is the time to contemplate deeply.
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
© 2022 Andrew Smith