The classic definition of a bear market is a period when average prices decline at least 20 percent. Many investors retreat to the sidelines during a bear market by cashing out. While this might preserve their wealth, it also represents a lost opportunity to profit from the bear market or to buy fund shares at deep discount in preparation for the next bull market. Your risk tolerance and time horizon will help guide your bear market purchases.
If you are risk-averse or have a short-term investing horizon, you might explore the universe beyond U.S. stock mutual funds. Many mutual funds specialize in the stocks of different countries and regions, some of which may be in the midst of a bull market. You might also want to diversify beyond stocks into other asset classes. Bonds, precious metals and real estate investments are all available through mutual funds. Money market mutual funds give you a convenient place to park some of your cash and lower your risk profile.
Some investors require monthly income. During bear markets, stock dividend yields usually rise. Dividend yields are the annual dividend payments divided by the stock price. Income-oriented mutual funds invest in high-yield stocks and bonds. As stock prices fall, you can accumulate high-yield mutual fund shares that provide monthly or quarterly payouts. “Junk” bonds and preferred stock funds will have the highest dividends, and fund portfolio diversification might limit your occasional losses due to bond defaults or halted dividends. Floating-rate bond funds offer prevailing interest rates with little price risk.
Stock traders often “go short” during bear markets. Shorting a stock requires you to borrow and sell shares, hoping the price declines before you must replace the shares. You cannot short mutual funds, but you can invest in mutual funds that short stocks. These inverse mutual funds try to provide a return that is equal in size and opposite in direction from the percentage returns of a selected stock index. Leveraged inverse mutual funds borrow money and use other techniques to double or triple their returns. Such funds might be very rewarding if you invest at the right time, but they also carry high risk of loss if stocks suddenly reverse direction.
Slow and Steady
If you are relatively young and investing for the long term, you can adopt a disciplined dollar cost averaging strategy. You decide in advance on a comfortable fixed amount to invest monthly in one or more mutual funds. When prices are falling, your monthly purchase nets you more shares per dollar than when prices are rising. Buy loading up on fund shares when they are “on sale” and buying fewer shares when prices are high, you might help keep your cost basis at or below your mutual funds’ net asset values. For long-term investors, bear markets become buying opportunities, especially if they reinvest their dividends to buy additional shares on the cheap.
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