What Can I Do to Protect My Investments From a Market Downturn?

Daniel Penzing
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When the stock market turns bearish, keep these tips in mind.

What can you do to protect your investments from a bear market? The answer is 'not a lot'. You aren't going to make money from a bear market, but you can reduce the losses you'll take if you know what to expect and the best places to invest based on your portfolio.

What is a Bear Market?

A bear market is a period of general economic recession or prolonged bearishness in investor confidence. The term also refers to a falling price of securities and commodities.

The performance and returns you get over the course of an investment will almost always depend on the time it took for you to sell it. The duration of the fall when the asset dipped along with your investment means your profits or losses are significantly increased.

A major indicator of a bear market is a 10 percent recession in stock trading. This is the point where investors sell their stocks with no real hope of a short or mid-term recovery, resulting in a market downturn.

The Street Calls It a Correction

Meanwhile, investment firms will call it a correction, and others, especially on Wall Street, will even call it a bull. You need to understand that nobody knows where the market is heading from one day to the next.

Don't Throw Out Your Stocks

Protect Your Investments When The Market Takes A Turn For The Worst

2017 has been called a market slump. While the markets are already bouncing back, there's still been room for volatility. Certain stocks have taken a beating. This volatility has created an opportunity to "buy low" and invest in the future. Also, for the investor who isn't looking to pull their money out, or doesn't have the means to, there are strategies that can be used to protect your investments during market volatility.

Set a stop loss.

A stop loss order can be set in the event of an abrupt price drop. This is a pre-determined sell order that gets triggered the moment a certain price threshold is reached. It ensures that you don't keep losing money. In essence, it's protecting your investment.

Use volatility to your advantage.

Volatility presents us with an incredible opportunity to pick up stocks that are on sale. When you see prices dropping, that is a sign that there is downward pressure in the market. It's the perfect time to buy. A better strategy, say financial experts, is to buy your stocks when the market is down, and your investment is protected by the stop loss order.

Invest in stocks that will grow.

“Prune” Your Stock Portfolio

The best way to weather the next major downturn is through diversification. If you have the money, go ahead and invest in a number of different investments. Hold multiple CDs and bonds with varying maturities. If your portfolio is properly balanced, you should be able to avoid losses over the long term. No matter what happens in the market, you’ll still have money to fall back on. You can also invest in a number of mutual funds for a bit of diversity.

If you don’t have the money to invest in multiple certificates of deposit, you can review your portfolio to determine whether you have any investments you can do without. You could then sell that stock and use the money to better diversify.

If you’re caught in a bear market, you’re going to want to avoid making any investments. However, if you’re not in a position to withdraw your funds, you should try to diversify through investing in different stocks with varying market caps.

Change the Way You Invest in Stocks

If you have been investing, you probably understand that owning a portfolio of stocks and/or bonds is an excellent way to create financial security for your future and the future of your family. As you may already be aware, however, trying to maintain that peace of mind in a downturn is nearly impossible.

If you have investments that have lost money, what can you do? There are several actions to consider.

First, realize that stocks and bonds do have risk, and that the risk increases when the market is experiencing a downturn. Ask yourself if you can handle a downturn. If so, are there measures that you can take to help protect you against a downturn? If not, then it may be time to reevaluate whether or not you should continue to follow the stock and/or bond market.

Start Increasing Your Cash Position

I know you made a nice profit this year, but I've got a word of caution. You remember that investment I mentioned was up 200% in 2013? Well it fell 53% in 2014. In March of 1942 the Dow Jones was at 227. In early 1943 it was at 150, and by July it was at 112. And this was with some great stocks like Coca Cola and General Motors trading at some ridiculously low valuations. By the end of 1945 it was back up to 189. In the early 1970s we had “good recession” that featured inflation going from 1% to 12% and back in a matter of months. In 1980 the Dow was at 937, then it dropped to 685 in August of 1982 to its bottom of 581 in October of the same year. By the time it hit bottom on March 1, 2009 it had lost nearly 50% since I started investing in 2003. Even the best investments have these big declines, sometimes a lot more than once in a lifetime. If you are feeling cocky about your great track record, you just might come back to earth with a resounding thud.

Strategies Beyond Your Investment Portfolio

There are certain steps you can and should take as an investor to protect your investments during a market downturn. First and foremost, you should strive to keep your investment portfolio diversified. It is also important to keep in mind that no investment is completely safe during a market downturn. More than anything, successful protection lies in limiting your losses to a minimum.

Investment Portfolio Diversification

Diversification is one way to decrease risk. By spreading your nest egg across several different investment vehicles, you have a greater chance of limiting your losses due to any one failure.

One of the keys when diversifying your portfolio is to consider your time horizon. For example, if you are young, relatively risk-free investments like bonds should be a part of your portfolio, while a larger percentage of stocks should be invested in for you. On the other hand, if you are nearing retirement, you may want to forgo certain riskier investments.

Individual Security Diversification and Risk Management

Since stock values usually have a greater effect on your portfolio's value, you will want to for that reason to invest in diversified, lower risk stocks, not just the lower risk exchange-traded funds. Remember that while you may receive less of a return with high-yield stocks, some of these stocks may be able to maintain stability during a dip in the market.

The Big Picture — Preparing for the Next Leg Up

There’s no doubt that the financial markets have been quite active in recent years. The Dow Jones Industrial Average, S&P 500 and NASDAQ have been at record highs for an extraordinarily long time. In fact, many market professionals are now projecting a market correction of historic proportions, and some say we’re gearing up for a leg down in the markets that will rival the dot-com bust of the early 2000s.

As a result, many investors are attempting to figure out what their next investment move will be. Should they set aside some money to weather the stock crash, or should they spend that money on recording labels, songwriters, and producers now in the hopes that their portfolio will be stronger down the road when the next big wave of growth comes? It’s a tough decision.

In this situation, we’d recommend that you explore ways to diversify your portfolio. Historically, the stock market has rewarded investors who were willing to take some calculated risks, but the problem with that approach is that it is often difficult to predict when you should take those risks.