Guest Article: How to Prepare for A Bear Market

Today I'm honoured to share a guest article written by Wes Chambers also known as @investingwithwes

Wes is a value investor from UK, and he is an amazing content creator that you should go follow on Instagram.
His signature content is company valuations and from time to time he shares background information about the value investing methodology and the piece I’m sharing with you today is one of these fundamental . Check back on the blog this fall for more articles from Investing With Wes.


How to Prepare for A Bear Market

By Wes Chambers

What Is a Bear Market?

A bear market is when a market experiences prolonged price declines. It typically describes a condition in which securities prices fall 20% or more from recent highs amid widespread pessimism and negative investor sentiment.

Bear markets are often associated with declines in an overall market or index like the S&P 500, but  individual securities or commodities can also be considered to be in a bear market if they experience a decline of 20% or more over a sustained period of time e.g., two months or more. Bear markets also may accompany general economic downturns such as a recession.

  1. Don't Get Stuck in Expensive Stock.

Investors of today are chasing the next exciting investment with a story. Buying into these companies can be the worst decision in your investing career because in a runaway bull market anyone can make money taking more risk than they should. But when the tide comes in the investors who take more risk in investing in securities that are trading way beyond their intrinsic value will get hurt the most as there is more downside risk. 

If you get stuck with expensive stocks when the tide turns, these expensive stocks tend to get hit the hardest as investor sentiment changes to assets that offer stability and those are the companies with cash flow trading at an attractive valuation. So, if you are invested in overvalued companies or speculative investments now is time to reconsider if you were actually investing or just speculating on future dreams and prospects that can't be justified.

    2. Diversified Portfolio.

Country diversification helps. If you are all-in on a specific country, then what happens if the market crashes, then you are in big trouble because it means your portfolio will be extremely volatile and you are more likely to give more gains back to the market. In a bear market, the idea is to give fewer gains back to the market, and Investors who are currently 100% invested in one market should try to look at different markets for great value opportunities because if one market crashes it doesn't necessarily mean all the others stock market will crash too.

Before you consider diversifying the most important thing to consider is whether the investment is priced below intrinsic value and you must be able to understand the business. I see so many people forcing diversification into their portfolio when all they are doing is making the situation worse (diworsification). I see so many investors buying Walmart, Coca Cola, and bank stocks when they don't even understand banks as it is very complex, and it needs subject expertise.

    3. Protecting Your Downside Is Very Important.

During a bull market, investors forget the old rules of investing which is to protect your downside at all costs because we never know when the market will go from favourable to unfavourable conditions. During bull runs investors forget what makes you a great investor: What makes you a great investor is to have the risk under control by always buying companies for less than what they are worth whilst demanding a margin of safety and desired return. When you follow these simple principles, you will experience less volatility in your portfolio compared to those who buy expensive companies.

    4. Try to hit 1s and 2s and not go for large returns.

In the stock market, most participants treat it like a gambling parlour where they want to get rich quick with that one lottery ticket stock and that has proven to never work over the long run.

Investing is about staying in the game to allow your money to compound and the way to do this is to concentrate on hitting the singles and the occasional doubles and not looking for home runs. If you have a portfolio with expensive stocks hoping they can be the next big thing you will get wiped out compared to someone who has a portfolio with the risk under control by protecting his downside. 

I compare this to baseball where if you keep it simple and get to base each time you will do well compared to someone who is more focused on getting home runs and looking for the spectacular which is difficult as you have a higher chance of getting out than actually getting the home run itself.

    5. Have Cash on Hand.

Warren Buffett said, 

"When it's raining gold, reach for a bucket, not a thimble."
When the stock market declines you want to have cash on the side-line as this is the time you can find a lot of bargains. The worst thing for an investor is to have no cash on hand and they watch opportunities past them. Usually in a declining market, this is the time a lot of investors can build the foundation for long term stock market success. 

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