With that said, it’s tough to know how long a bear market will last or how hard it will hit stock prices.

But since they’re unavoidable, it’s best to be prepared for them. By picking your investments wisely, you can get through a bear market unscathed. In fact, you could even profit from a bear market — both while it happens and afterward when things begin increasing again.

Below are several places in which smart investors move their money during a bear market to minimize the effects on their portfolio and position themselves for future success.

Defensive Stocks

You may want to get defensive with your stock picks in bear market conditions. Defensive stocks generally have stable earnings, long operational histories, strong balance sheets, and consistent dividends.

In bull markets, these stocks don’t do as well as the rest of the market — but when the rest of the market drops, defensive companies become some of the top trending stocks.

Also, as previously mentioned, they have a history of paying solid dividends. Income is always helpful in a bear market.

Stocks in sectors not tied closely with global economic changes tend to be defensive stocks as well. These companies provide “needs” to consumers and businesses, and so they will always have stable revenues relative to the market at large. Companies in health care, consumer staples, and utilities are all good examples, as well as some REITs.

Short-Term Bonds

Bonds provide much-needed stability when the stocks around you are crashing. In fact, they often (but not always) rise as the stock market falls.

Bonds also provide you with income, further protecting you against bear market conditions.

Focus on short-term bonds, as they are less likely to experience losses in a bear market. Long-term bonds have a higher interest rate risk — when interest rates rise, long-term bond performance could fall.

Also, think about buying municipal bonds. Your interest earnings are tax-exempt — and if you buy your home state’s municipal bonds, you’ll avoid state and local taxes as well.

Short-Term and Long-Term Puts

If you have long positions in the market and you sense that bearish times are on the horizon, you can limit your potential losses by buying puts for those stocks.

For example, let’s say you own 100 shares of Stock X at $40 per share. You could purchase a put with a $45 strike price to hedge against Stock X dropping too low.

Should the share price somehow increase above $45 when the put expires, the put becomes worthless. Your stocks are more valuable, but make sure to factor in your put’s purchase price to ensure you’re still profiting.

If the share price ends up below $40 per share, then you could exercise the put and sell your shares for $45 each, earning you $5 per share minus the put option’s purchase price.

Remember that options trading is a more advanced type of trading strategy and often requires a margin account. Make sure you understand all the risks involved.

Selling Naked Puts

If you have a larger appetite for risk and have access to a margin account, selling naked puts could be a profitable move.

A naked put is when you sell a put, but you don’t have the cash available to pay for the purchase of the underlying securities. Using naked puts correctly can help you acquire stocks at a discount with money you don’t have.

To illustrate, let’s say Stock X is trading at $40 per share. Since we’re in a bear market, Stock X is falling. You sell a put option with a strike price of $35 per share. You collect $4,000 ($40/share*100 shares).

Should the price fall to something like $30 per share, your buyer will exercise their put to sell the shares at $35 per share. You now have to buy $3,500 worth of Stock X, leaving you with a profit of $500 minus commissions (perhaps you use that profit to buy even more stock) and plenty of Stock X shares at a discount.

But perhaps your forecast was slightly off, and the price ends up at $37 per share. Or maybe it was way off, and the price goes up to $45 per share.

In either of these situations, a buyer won’t want to sell shares worth $37 or $45 for $35 — meaning you keep all of the premium collected minus commissions.

401(k)

Don’t forget about your 401(k) if you’re employed. A bear market is a great time to build up your retirement savings, especially if retirement is still far off for you.

It’s true — at first, it’ll be disheartening to see your retirement savings slashed because of a market plunge.

However, you should keep up your contributions. Investments are cheaper, and you can take advantage of dollar-cost averaging with regular automatic contributions.

It’s also worth noting since your 401(k) contributions are pretax, you’ll have more money to work with.

Make sure to hit your maximum matching bonus — you’ll thank yourself later when the market turns around and your retirement savings are healthier than ever.



In Summary

Bear markets seem scary at first, but as you can see, there are several strategies you can employ to reduce the effects on your portfolio and position yourself for profits both now and in the future — all while others may be seeing substantial losses.