3 Things The World’s Smartest Investors Do In Every Bear Market

It’s official: the stock market entered bear market territory a few months ago. And with the Federal Reserve poised to continue aggressively raising interest to fight inflation, it’s unclear when this bear market will end.

At this point it is too late to prepare anything. Nonetheless, there are still things you can do now to help your investments weather the storm. Here are three things savvy investors are doing to shore up their portfolios.

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1. Resist the urge to chase the asset classes with the best returns

If you’re invested in stocks, chances are you’ll be in for some hefty losses this year. You would be in good company. So are the richest people in the world, and their net worth has plummeted as a result. Even Warren Buffett, who prefers boring and predictable trades, has reported significant declines. Berkshire Hathaway (BRK.A -0.81%) (BRK. B -0.62%) announced that its stock portfolio lost over $63 billion in the second quarter of 2022 alone (down 21%)!

By and large, stocks are not a happy place during bear markets. Heck, even bonds haven’t fared that well, defying the old adage that they’re “safe” (bond values ​​fall when interest rates rise, although if you hold them to maturity you get back the bond’s principal value) . But what went well this year? Commodities (such as agricultural products and mining materials), energy, and cash. We’re about to make money, but as for the stuff running higher this year, resist the urge to chase those returns.

This is because commodities and energy tend to be cyclical in nature and are not steady and consistent performers. Granted, if you think inflation is going to keep rising for a few more years, invest some Investing your portfolio in top resource and energy companies might not be a bad idea. Still, when it comes to the commodities themselves, invest after they’re already rising in value could just set your portfolio up for another drop. For example, oil prices have fallen sharply since peaking earlier this year. Something similar has happened in previous bear markets – a sharp increase in inflationary pressures can reverse course just as suddenly and unpredictably.

I’m not saying I expect oil to keep going down from here. Basically, however, the following applies: Don’t chase after the hottest trend at the moment! If you’re a long-term investor (you’ve got at least a few years left until retirement, or you’re already retired and need your portfolio for at least a decade or two), the best move is to do nothing at all, or just make small adjustments before.

2. Sell the stocks that are “floating naked”

Speaking of small adjustments, one of the things bear markets do is expose companies in poor financial shape. Again we turn to the Oracle of Omaha for help: Buffett has said, “You don’t find out who’s been swimming naked until the tide goes back.” The Fed is raising interest rates and tightening the cash supply, and this is the proverbial “tide of the easy money”. Now that times are a little tougher, some companies may not be in the strong position we once thought they were.

But how do you tell who is “swimming naked”? Declining sales and profitability are not necessarily a red flag. Many of these companies are poised for a strong recovery. However, when declining sales and earnings are paired with a weak balance sheet, that’s a different story. Companies that have a lot of debt and little to no cash, for example, could run into trouble.

In particular, examine a company’s current cash flow statement and calculate its free cash flow (operating income less capital expenditures). Now compare that number to how much cash and investments they have on their balance sheet. If a company is generating negative free cash flow at a rate that would drain its coffers within a year or two, that company could be in dire straits.

However, be careful with this analysis. If a company is in dire financial straits, chances are its stock is, too beautiful fueled. At this stage, companies have options that could add value to you, the shareholder – they can raise more money or sell themselves to a competitor. So don’t be too hasty with the sale.

However, if things are looking particularly bad (not for the stock price, but for the company itself), it may be time to cut your losses and allocate those funds to an industry peer who is in better shape to recover from the bear market to recover ends.

3. Make sure you have the money you need for the next year or two

Here’s another reason for you could Sell ​​a stock in your portfolio: You need cash within the next few years.

Now, don’t get me wrong: the last time you want to sell a stock is after the market collapsed. That’s why it’s especially important to always have a position in cash — or other highly liquid assets like bonds that mature in a year or two or CDs at a bank. This is true if you’re young and have many years to go before retirement (build that emergency fund!) or if you’re already retired.

However, if you find that you need a little more cash in the short term than you initially anticipated, it might be a good idea to raise some cash now. Bear markets can last longer than we expect. The average duration of a bear market is around 10 to 12 months, but that’s just the average. Sometimes they can take longer.

Start selling the companies you have lost confidence in. However, an important word of caution here is to avoid selling high-quality companies just because it feels good to have cash in the bank right now. These quality companies are the ones that will help your portfolio eventually recover.

Whatever you do, don’t panic

Bear markets are no fun. There can be some ugly days when the market falls a steep percentage. It is also common for some upward momentum to be wiped out by unanticipated economic setbacks. This leads to strong emotions. Whatever you do, don’t panic and act on those powerful emotions. This can simply set the stage for more pain and regret in the future.

But take courage. Bear markets don’t last forever, and the end of a bear market is often announced after the fact – after a robust recovery for the market and the economy has already taken place. Keep a cool head, prefer small adjustments to big and hasty decisions, and focus on the long-term.

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