Investing in a bear market presents new challenges for conservative investors. No one wants to loose money. Fortunately, there are safe strategies for conservative investors to continue to invest their money. This conservative investment idea is designed to save your IRA from experiencing losses during a bear market. In addition, it helps to position you for the recovery in the stock market once it begins.
Cash is King
When investing your IRA portfolios during a bear market the best strategy is to stay in cash, use income investments, and/or be short. In a bear market, I divide my IRA portfolio into three segments, not necessarily equal. My objective is to preserve my capital until the market turns around with a secondary objective to make some money.
Invest the first segment in a money market fund. Cash is a position that has no risk and earns a small return. Money market funds are fine for this. They are safe and you can access your cash when you need to do so. The percent of your portfolio that you place in this segment depends on your comfort level with the other two strategies.
Build a Ladder
Use the second segment to capture slightly higher returns from longer-term income investments than what is available through money market funds. You build what is called a ladder. The idea is to invest in longer term securities that are completely safe. You can do this with bank CDs or Treasury bonds. Assume you have allocated $24,000 to this segment. At the beginning of the bear market or when you decide to get out of the market, go to your bank to set up six certificates of deposit (CD) as follows:
$4,000 in a 1 month CD $4,000 in a 2 month CD $4,000 in a 3 month CD $4,000 in a 4 month CD $4,000 in a 5 month CD $4,000 in a 6 month CD
As each CD matures, roll it over into a 6-month CD. After six months, you will have six separate 6-month CDs maturing every month. Continue to roll them over as each one matures. You could use one year CDs as well.
When the bear market looks to be over, you can then move the money from each CD as it matures into the market over a six-month or one-year period depending on the maturity of your CDs. This way you can enter the market in stages and you will not commit all your money at once.
You can also use bond mutual funds to accomplish the same idea, if that is what you have available in your IRA.
The concept of building ladders is commonly used in bond investing and in situation where the investor needs access to their money on a regular schedule. You can set up ladders for college savings, retirement payouts, or any other situation where you want to receive your money over a period of time.
Short the Market
In the third segment, hold a portion of your portfolio in and ETF that shorts an index such as the S&P 500. If you can only invest in mutual funds then use one of the inverse mutual funds. The purpose of this segment of your money is to take advantage of the weakness in the market and make some money. You are in a bear market, so being short takes advantage of the downtrend of the market. This segment will experience more volatility during bear market rallies. The level of volatility you can stand will help determine how much money you commit to shorting.
This strategy works for portfolios where you are somewhat limited in where you can place your money such as IRAs. It is conservative in that it stays primarily in very safe investments and the securities you buy are with the overall trend in the market.
Transition Bull to Bear and Bear to Bull
The decision whether we are entering bear market can be made easier, if you stage the building of your bear market portfolio over a couple of months. For example, if you believe we are about to enter a bear market, you can close out most or all of your long positions and move to cash. This might take place over the course of several months. For more on how to identify a bear market, please see xxx article.
If all indications still point to a bear market, then start to build your ladder using either CDs or bonds. Then start an initial investment in a mutual fund or ETF that shorts the market such as the S&P 500. During the course of a bear market, there will be rallies that last from a couple of weeks to a couple of months. If you can, try to buy more shares of a short fund at the top of one of these bear market rallies and then sell some of the shares at the next low point. Do not want to sell all my shares, since the overall market trend is down and you want a downward bias to this portion of your portfolio. Your goal is to take advantage of the volatility of the market.
This buying and selling of short mutual funds is what changes the dollar size of your cash position. A keep some money in cash just to be conservative. The amount you invest in a short position depends on how much risk you wish to take with your retirement funds. To me it is prudent to risk no more than 50% in a short position. However, that depends on your own financial situation and your ability to sleep at night.
The transition from a bear market to a bull market tends to follow the reverse course. At the first sign, the bear market is ending; close out the short positions moving to cash. Have a set of stocks and ETFs that you want to be ready to buy should the new bull market be real. Start to establish positions in the best stocks and funds that should do well in the early stages of a bull market. As long as the signs of a bull market remain, move more cash into these early positions over the course of a several of months. Start to draw down the ladders, adding the cash to long positions until fully invested.
The objective of this transition process is to capture the vast majority of the trend, yet not commit all your money at once. It gives you some flexibility to adjust your strategy incase something unforeseen takes place.
The Bottom Line
Conservative investors can overcome the affects of a bear market by using simple strategies to allocate their IRA portfolios in safe investments. By employing, the techniques mentioned you could save your IRA portfolio from a meltdown. After all, the first rule of Warren Buffett’s investing strategy is to not loose any money. It is a rule well worth following.
Principle: Hans E. Wagner, CEO of Trading Online Markets LLC and Peregrine Advisors LLC
I began investing in high school and have remained active in the markets. A graduate of the US Air Force Academy with an MBA majoring in Finance from the University of Colorado, I continued to invest throughout my career in the US Air Force, Bank of America, Coopers & Lybrand, and working for Ross Perot before retiring at 55. During that time I have gained a very good understanding of what works and what doesn’t. I hope to impart that knowledge to others, so they can achieve financial independence as well.