In life, there are peaks and valleys. There are times when you feel on top of the world and nothing can go wrong. Then there are times when you feel as if nothing goes right and you’re at rock bottom. As different as they may feel, good and bad times both have something in common: they are not sustainable. Good times will come to an end no matter how long we want them to last. Also, bad times won’t last forever and will eventually turn around. The same can be said of the stock market. The stock market has been providing outstanding returns over the last few years. An uptrending market, like the market we are currently experiencing, is known as a bull market. Conversely, a downtrending market is called a bear market. As of this writing, we are in the midst of a 10 year bull market. Over a span of a decade, the market has grown consistently and investing has been relatively easy. However, all good things must come to an end. On average, bull markets last about five years. The stock market will crash. Its not a question of if, but when. According to some indicators, our current decade-long bull market could be coming to an end very soon. Here’s how to protect your money when the inevitable bear market comes roaring back.
Investing defensively simply means placing your money in investments that allow you to minimize risk while maximizing the potential to profit regardless of market conditions. The most defensive way to invest is an all cash portfolio. However, an all cash portfolio will still lose value over time thanks to inflation. Returns on cash generally range anywhere from 0.5 percent to 1.5 percent, which is lower than the rate of inflation. So, if you want to avoid losing, you have to invest. But where?
Other than cash, the most defensive place to park your money is in a Certificate of Deposit (CD). A CD is a type of savings account that holds a fixed amount of money for a predetermined amount of time. CDs typically come in terms of 6 months, 1 year, 2 years and so on, up to 10 years. CDs typically have higher interest rates than regular savings accounts and are a good way to protect your principal while hedging against inflation.
As stocks sink, many investors buy bonds. Bonds are loans from investors to a municipality, a corporation or the government. A bond is basically an I.O.U., but what makes bonds good investments during a bear market is their low volatility. When stocks crash, bonds will usually remain stable. Stocks will have higher returns than bonds, but bonds have less risk. Typically, bonds offer a predictable stream of income in the form of interest payments on predetermined dates.
While many economists suggest moving money out of stocks during an economic downturn, there are certain stocks that will still offer consistent growth. To find solid stocks in a bear market, look for companies with a long history of strong cash flow that aren’t overburdened with debt. Dividends are a plus. Healthy companies that pay dividends are good investments in any market. Even if dividend stocks under-perform, they can still offer a decent return on your investment in the form of dividend payments. It’s best to stay away from retail stocks and other consumer discretionary stocks during a bear market, since people tend to reign in spending during an economic downturn. But, people still need to eat, right? Stocks like General Mills (GIS), McDonald’s (MCD) and Coca-Cola (KO) will remain stable even in a recession.
Keep in mind that I’m not a professional advisor and the advice in this article is strictly my opinion, but I believe stocks are a good investment vehicles regardless of the economic climate. Although another market crash is inevitable, there’s no need to panic and pull all of your money out of the market. A bear market is not the kiss of death for your nest egg, despite what all the talking heads say. Although history says we are overdue for a market downturn, there is no way to predict when a bear market will occur. Preparation is the key. When doom and gloom hits the markets, a good defensive investing strategy can preserve the value of your portfolio and ensure that your nest egg remains intact.