Surviving A Bear Market

If you are invested, the best course of action when going through a bear market is to do nothing and stay the course. That's right. Take a nap, take a vacation, have a margarita. In fact, jumping out of the stock market and trying to get back in when the market hits a low would be to your disadvantage. This would force you to engage in what's known as "market timing*," something that even veteran investors find a challenge. By remaining in the market, at least you'll be sure of being there when the market rebounds.

If you do not have a solid financial plan in place and feel you must take some course of action, consider doing the following during those declining markets:

1 Go sector shopping: Historically, some stock sectors do better than others in declining markets. For example, high-dividend stocks tend to be less volatile than other stocks. Sector-wise, utility stocks, consumer cyclicals, service-oriented companies, food, and pharmaceutical stocks tend to do better during an economic downturn than others. There are no guarantees, however; utility stocks face challenges from deregulation, and pharmaceutical stocks face competition from generic drugs. Although some stock sectors tend to outperform others during a bear market, when the market does turn bullish again, these stocks won't rise as fast or as high as high-flying sectors like technology or emerging-market stocks.

2 Diversify: As always, don't put your eggs in one basket. Having a carefully chosen mix of investments is advisable anytime, but it's especially advisable in a down market. Remember, relying on company stock for as much as 80 to 90% of their 401(k) plans cost Enron employees dearly. To those investors, the lesson on diversification was a costly one. The ideal method for selecting investments is to have a mix of different, noncorrelated asset classes classes that don't tend to move in the same direction as the broader indexes at the same time. This tendency is represented by the asset's beta*, which can be found on most financial websites. The lower the beta, the less the asset is correlated to movements of the broader markets. Although studies have shown that holding a judicious mix of growth and value stocks, possibly in international as well as US companies (and some bonds and cash investments too), is a great way to minimize investment loss, it doesn't help much if they are all strongly correlated.

3 Think incrementally and keep buying: When stocks finally rebound, they move much higher than their price levels had been just before a bear market. This was the case during the last two bear markets, one in 1987 and the other in 1990. If you contribute regularly to your 401(k) plan, your IRA plan, and your stock and mutual fund investments, you could be buying at the dip*. This gives you the opportunity to take advantage of a potential bull market rally when it arrives.

4 Place more money into fixed-income products: Keeping your investments in products such as US Treasury bonds and money market bonds certainly reduces your risks. By doing so, however, you risk being on the sidelines when the stock market rebounds.

5 Consult a financial advisor: It doesn't hurt to get professional advice on how to survive a bear market.

6 Stay calm: Bear markets tend to dissipate fairly quickly, and bull markets usually last much longer. Consider this before doing anything rash with your (until recently) high-flying investment portfolio.

Brian O'Connell is a Philadelphia-based freelance financial writer. He can be reached at briano@tradenet.net.

Current and past articles from Working Money, The Investors' Magazine, can be found at Working-Money.com.

*See the comprehensive Traders.com Glossary.