Remember first that you don’t always have to be fully invested. Many long-term investors believe that Warren Buffett remains invested in stocks throughout a bear market.
Nothing could be further from the truth. Buffett raises cash and shrinks his position sizes when he thinks that valuations are expensive.
Wait to Buy
He does this because he doesn’t see a lot of good investment opportunities during the late stage of a bull market. Buffett invests heavily when he thinks that valuations are cheap and opportunities are plentiful.
Blindly holding onto stocks throughout a recession can lead to your portfolio being underwater for more than half a decade.
So remember: if there are no good investment opportunities, stay in cash. Don’t force yourself to take investment opportunities when there are few good ones available.
Wait a Little Before Buying Long-Term Bonds
Right now we are in a unique situation in which:
- A bear market might be two to three years in the future.
- A bear market is not imminent either.
- The current bull market still has one to two years left.
This means that it’s not a good time to invest in long-term Treasury bonds yet. Interest rates are extremely low right now, and with the Fed on track to hike rates another two times in 2018, interest rates will rise throughout this year. That means bond market investors will probably lose money over the next year.
Investing in long-term bonds will become a good idea when the next bear market begins. Rates don’t usually rise during bear markets because central banks are lowering interest rates, unless there is hyperinflation.
Treasury Inflation Protected Securities
Historically, inflation always rises during the last legs of an economic expansion — and that’s what we’re in right now.
Investing in the stock market to protect yourself from inflation in the short run is not a good idea because it can be very volatile. The simplest way to protect yourself from inflation is to buy Treasury Inflation Protected Securities: Their value rises and falls with inflation, effectively giving you protection from rising inflation.
Some people still feel that they have to invest in stocks. If you are one of those people, at least recognize the danger of a bear market and try to minimize your losses. Investing in dividend stocks is better than investing in growth stocks during a bear market. Here’s why:
- Growth stocks s (like Facebook, Amazon, Netflix, and Google) fall faster than average during bear markets.
- Growth stock rise faster than average during bull markets.
Dividend stocks are exactly the opposite; they tend to be slow-moving companies with low volatility (for instance, utilities). In a bear market, they typically fall less than the rest of the market.
Plus you also get dividend yield even during the bear market — but keep in mind that dividends tend to get reduced during bear markets.
Prepare for the Next Bear Market
If you own all stocks right now, you might consider moving entirely to cash when you think the next bear market is just around the corner — then either stay entirely in cash or shift to short-term Treasury bonds.
The Fed tends to lower interest rates during bear markets, which means that short-term bondholders may be rewarded.
Troy Bombardia is a professional trader who shares his thoughts on the markets at Bull Markets.
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