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How to protect your investments during a bear market

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bear market

How does saving 20 cents on your favorite $1 candy bar sound? A price decrease like this might not transform your financial life. However, a 20% decrease in the price of financial securities during a bear market could be game-changing for your investment plan. 

But what exactly is a bear market? How has the coronavirus contributed to it? What should you do with your investments? The current bear market has investors worried about what action they should take, but don’t worry — here at Academy we’ve got some tips to help you understand this phenomenon and some ideas about what you can do about it. 

What is a bear market?

A bear market is a market trend in which investment prices decline by at least 20% or more over two months’ time. Indexes, commodities, stock-markets, single stocks, and just about every other type of financial instrument can be affected by this phenomenon. 

The term “bear market” gets its name from how the bear usually attacks its prey: it slashes its prey in a downward motion with its claws. In a similar way, the values of stocks are slashed during a bear market.

Bear markets may emerge as a result of major changes in the economy, disasters, or political instability that contribute to a downward trend in the prices of individual securities and the market as a whole. Most recently, the coronavirus pandemic has created the conditions for a down market.

As share prices continuously decrease, investors lose confidence and may withdraw from the market in an effort to avoid future losses. This further reinforces the economic downturn.

Read also: 3 key moves to make during a stock market crash

The most recent example of this is when the Dow Jones Industrial Average dropped from 29,551.42 to 23,553.22 on March 11, 2020. While this fall is certainly dramatic and indicative of how the Coronavirus is affecting the economy, it’s not the first time the economy has experienced a bear market.

According to Dow Jones Market Data, there have been a total of 26 bear markets over the history of the S&P 500.

How has Coronavirus contributed to today’s bear market?

One of the driving forces behind a bear market is loss in investor confidence that results from a slowing economy, stock market crash, crises, or other factors. The Coronavirus pandemic has caused all of the above. 

Unemployment rates

The US and countries around the world have begun implementing quarantine, social distancing rules, and other measures to attempt to “flatten the curve” of the infection rate and prevent the collapse of healthcare systems. This has caused unemployment to increase dramatically.

As of May 2020, the US’s unemployment rate jumped to about 15% (the highest level since the Great Depression). Similarly, Spain’s unemployment rate is hovering around 14%, and countries throughout Latin America and the rest of the globe have also faced serious unemployment increases. 

Stagnation of consumer activity

As a result of businesses closing, quarantine, and job loss, consumer activity has stagnated. This decrease in consumer activity has not only led individual businesses to fail, but it may be so dramatic that global economic growth could be affected.

Industrial production

Also related to quarantine, social distancing, job loss, and consumer activity stagnation, industrial production has slowed on a global level. With companies producing and selling less, they are less profitable.

These difficulties trigger investors to sell their stocks in an attempt to cut losses. As a result, the market further declines.

What should I do during a bear market?

Needless to say, investing during a bear market can be risky. Most investors choose to sell their stocks in an effort to prevent additional losses. While this reaction is understandable, it might not be necessarily the best course of action.

To figure out what you should do during the bear market, make sure to incorporate the following skills into your financial planning:

1. Diversify

Even during a bear market, many smart investing principles can still help you be successful. Protect yourself by diversifying your investments. Distribute your money in different types of securities to be more resilient to market fluctuations. Consider investing in exchange-traded funds or mutual funds.

These securities contain a diversity of stocks and other financial instruments. Portfolio diversification protects you during the bear market and sets you up to enjoy long-term returns when the stock market recovers and transforms into a bull market. 

2. Re-evaluate your risk tolerance

Always be honest about the amount of risk you can (and should) be willing to tolerate with your investments. Your risk tolerance must consider numerous factors, like your investment timeline, goals, and income.

If any of these factors have changed during the pandemic, your risk tolerance (and therefore investment strategies) probably should, too.  

3. Maintain a long-term view of your investments

It can seem like a good idea to sell your investments when you notice a drop in their value. Some investors believe that, by doing, so they can prevent greater losses later on. But, in many cases, investors simply lock in their losses when they do so. Historically speaking, the market has always been able to recover from recessions and even depressions.

Making emotional decisions when investing is a sure-fire way to lose and to deviate from your long-term goals during difficult times. Remember that cheap investments during a bear market can (and often do) gain value following a downward turn. For this reason, it may even be a good idea to conservatively invest in suddenly cheap securities. 

The bear market caused by the Coronavirus pandemic has most investors on edge. However, by understanding exactly what a bear market is and some strategies to protect yourself during an economic downturn, you can improve your financial fitness.

For more ideas on how to maintain your financial wellness, check out the rest of the Academy education library. 

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