In a bear market, it’s important to play defensively to keep your portfolio from losing a lot of money. Therefore, risk management in a bear market is key, and diversification is one of the most important things to do. It can help lower volatility and lessen the effects of market downturns.
Furthermore, defensive stocks such as consumer staples, utilities, and healthcare tend to perform better during a bear market because their products and services are frequently in high demand and generate a lot of liquidity.
While the temptation may be to sell all stocks during a bear market, it’s important to remember that these downturns are temporary, and in the long run, stocks will typically recover.
This article will give you an overview of some ways to protect your portfolio during a bear market through risk management. These include diversification, defensive stocks, and ways to lower your risk.
In a Nutshell
- The typical bear market lasts long enough for investors to react
- Portfolio diversification and a preference for higher quality stocks can lower bear market risks and increase long term returns
- Defensive stock sectors, such as consumer staples, utilities, and health care, typically outperform during bear markets
- Government bonds offer significant diversification benefits and the possibility of high returns in a downturn.
Risk Management in a Bear Market: Playing Defensively
Making sure your portfolio is adequately diversified across a range of asset types, not simply stock sectors, is the first thing to do as part of your risk management in a bear market strategy. Diversification lowers volatility, which tends to go up when the market is bad and can cause investors’ portfolios to change in ways that are unsettling.
In the business world, the rearview mirror is always clearer than the windshield.
James Lam
A study of returns during the Great Depression found that from September 1929 to February 1937, an investment portfolio with 30% U.S. stocks, 50% bonds, and 20% cash would have produced average annual returns of 7.3% when deflation was taken into account. This is the same as the average real return from 1929 to 1998. The performance of the 30/50/20 portfolio even surpassed that of the one that was 100% invested in fixed income, highlighting the advantages of diversity.
On the equities side, defensive stock categories have performed better during downturn markets, including consumer staples, utilities, and health care. Regardless of market or economic situations, these industries often have a high demand for the products and services they offer. They also produce a lot of liquidity, which helps to support a high dividend yield.
Many large cap corporations with solid balance sheets are found in these industries, and their equities often do better in bear markets than small cap or growth stocks. There is evidence that riskier stocks have not outperformed safer stocks over the long term, despite the fact that riskier equities are never riskier than during a bear market. This implies that removing risky equities from a portfolio during a bear market may also result in long term dividends.
Risk Management in a Bear Market: Sell
Why wouldn’t an investor just stay away from stocks altogether, since they are expected to lose value in a bear market? During bear markets, which often lead to panic selling, any investor might be tempted to sell their stocks and get cash or short term government bonds instead.
Advertisement
In order to considerably increase their long term profits, many investors who sell during a slump miss the sudden rallies that typically signal the conclusion of the weak market. Some are likely to become entrenched and continue to be underinvested after missing the market shift.
While selling all of your stocks during a bear market may seem wise, doing so actually amounts to a very dangerous wager on your ability to time the market and against the stock market’s lengthy track record of fully recovering from bear market losses.
Risk Management in a Bear Market: Hedging Risk
Investors have a number of products to select from if they want to do risk management in a bear market or seize tactical chances. These include long term Treasury bonds, whose value is expected to rise if a bear market is followed by a recession, as well as inverse ETFs, short positions in specific stocks, and put options to make money from sudden drops in stock prices.
Annuities are a type of structured investment product that can limit the amount of money you can make on the upside while protecting you from the downside. All hedges have a cost, which is usually shown by the option premium paid or, less obviously, by the maximum return cap on annuity policies for annuitants. Equity portfolio diversification and risk management can offer equivalent benefits at a lower cost.
The COVID 19 pandemic’s arrival sparked a swift but devastating bear market, with the S&P 500 losing over 34% of its value in just five weeks, and it bottomed out on March 23, 2020. On August 18, 2020, the S&P 500 reached its former high once again.
Risk Management in a Bear Market: Buy Bargains
In hindsight, every previous bear market was an opportunity to buy stocks at a discount because stock prices always went up after them. Dollar cost averaging takes advantage of these possibilities by making regular investments in stocks, such as $500 each month.
The riskier equities that frequently excel in the early stages of a recovery may also be purchased by an investor who is certain that a bear market is about to come to an end. Naturally, they are the equities that could suffer if the anticipated bull market turns out to be a bear market instead.
Wrap up for Risk Management in a Bear Market
A bear market is not for the timid, and it is typically not the time to take unwarranted risks. And that holds true for both the danger of selling all of your stocks and the risk of having a 100% equity investment.
Being mindful about risk management in a bear market, diversifying your holdings and choosing firms with strong, well capitalized balance sheets rather than overly expensive ones can yield significant returns.
FAQs | Risk Management in a Bear Market
Focus on risk management in a bear market. Making sure your portfolio is diversified across a range of asset types, including bonds and cash, can lower volatility and protect your portfolio during a bear market. Additionally, defensive stock categories such as consumer staples, utilities, and health care tend to perform better during downturn markets.
Selling all of your stocks during a bear market can be dangerous as it is a bet on your ability to time the market and goes against the stock market’s track record of fully recovering from bear market losses. Instead, consider dollar cost averaging and taking advantage of opportunities to buy stocks at a discount.
Investors can reduce equity risk during a bear market by investing in long term Treasury bonds, inverse ETFs, short positions in specific stocks, and put options. Annuities are also a type of structured investment product that can limit its upside while providing downside protection. Keep in mind, all hedges come with a cost.
Yes, every previous bear market has been an opportunity to buy stocks at a discount as stock prices always go up after them. Dollar cost averaging by making regular investments in stocks can take advantage of these opportunities. Additionally, riskier equities that perform well in the early stages of a recovery may also be purchased by an investor who believes the bear market is coming to an end.
Article sources for Risk Management
At Capital Maniacs, we are committed to providing accurate and reliable information on a wide range of financial topics. In order to achieve this, we rely on the use of primary sources and corroborated secondary sources to support the content of our articles.
Primary sources, such as financial statements and government reports, provide firsthand evidence of financial events and trends. By using primary sources, we are able to directly reference information provided by the organizations and individuals involved in these events.
Secondary sources, such as financial analysis and commentary, interpret and analyze primary sources. While these sources can be useful for providing context and background information, it is important to use corroborated sources in order to ensure the accuracy and reliability of the information we present.
We take pride in properly citing all of our sources, both primary and secondary, in order to give credit to the original authors and to allow our readers to verify the information for themselves. We appreciate your trust in our website and are committed to upholding the highest standards of financial journalism.
- UBS – How to Manage Risk in a Bear Market
- Evanson Asset Management – Asset Allocation for Bears
- Hartford Funds | Risk Management – 10 Things You Should Know About Bear Markets
- O’Shaughnessy Asset Management – A Historic Opportunity in Small Cap Stocks
