There's an overwhelming sense of chaos when investors first realize they're in the middle of a bear market.
Here's how to make a bear market work for you.
Take a Deep Breath
The market is in a downturn. But that doesn'tyou've lost control of your portfolio.
Do you know why the market is suddenly tanking? If you don't, that's the first step you should take.
Taking a little time to understand what's causing the market to dip allows you to respond accordingly. Despite a downturn, a calm investor with a game plan can protect his assets, and even profit. The key is to keep your composure in the eye of the storm.
Check Your Asset Allocation
One of the best ways to beat a bear market is to be diversified. Be sure that you're not overweighted in areas that are taking an extra beating, and be sure that your portfolio is age-appropriate. For example, older investors who are facing retirement in 5-10 years should generally not have a heavy concentration in stocks; a bear market could irreversibly wipe out enough of their portfolios that they'll have to postpone retirement.
Look Into Value Stocks
Growth stocks generally fare worse than value stocks in bear markets because growth stocks tend to come from younger, smaller, and riskier companies that are reinvesting every spare dollar of capital. Value stocks, on the other hand, tend to pay dividends (which provide bear market investors with much-needed cash) and are often perceived to have more stable earnings.
That's not to say that you should completely avoid growth stocks in bear markets; innovative, new ideas are often associated with growth stocks. If you're sure of your analysis of the company (and you're very, very brave), a bear market can be the perfect time to snag great stocks at a major discount. The idea is to be more careful with your allocation between the two.
One Word: Countercyclical
A well diversified portfolio should contain some countercyclical stocks. These defensive plays don't generally boast high returns when times are good, but they're famous for their ability to weather economic dips.
Countercyclicals are easily identifiable because of their low betas (under 1.0), meaning that their volatility isn't strongly connected to the overall volatility of the market. Countercyclical stocks are often businesses that produce necessary and cheap products that consumers can't really go without -- things such as utilities, water and food.
Remember Fundamental Analysis
Fundamental analysis is the analysis of those elements of companies and industries that transcend the financial statements, such as brand recognition, customer loyalty, innovation, labor-force quality, and management talent. Companies and industries with solid fundamentals are often companies and industries that consumers can't live without; thus, they're more likely to fare well during a bear market. Consider the macroeconomic state of the economy, and look at those industries that are working and those that aren't.
One of the most important things a bear-market investor can do is avoid panic. Panic selling -- a wide-scale sell-off that causes a sharp decline in prices -- is for suckers and people who took on too much risk. It's almost always an emotional reaction to fear; it rarely involves reasoned, patient analysis. And quite often, panic selling gets so out of hand that exchanges halt trading until people get their heads together. If a huge sell-off occurs, don't be swayed by the panic. The market may be down 50% indeed, but to the forward thinker, a bear market can be the buying opportunity of a lifetime.