Nobody likes to watch the stock market fall, and with the S&P 500 down over 10% from its previous highs, we can now officially say that we've hit correction territory. Whether you're a millionaire or you're just getting started with investing, it never feels good to lose money -- which is why you're better off prepared when the inevitable dives hit.
Here, we'll go over four strategies to make the most of a potential bear market.
1. Build cash
In a market that's still facing stretched valuations by almost any measure, cash retains important value -- primarily in its flexibility and optionality. While you won't earn a ton of interest keeping large amounts of money in cash reserves, you'll accomplish two important goals.
First, knowing that you have cash in the bank -- ready to be spent on necessities or emergencies -- is a huge advantage when the market falls. Simply having enough on the sidelines means you won't need to rely on market performance to meet your needs. This feels wrong when the market is at or near its all-time high, but it couldn't be more psychologically comforting when we veer into correction territory.
Second, cash prevents you from selling stocks at a loss and from deviating from your long-term financial plan. Selling stocks during times of market turmoil is one way to almost certainly have less in the long run, which is why a cash buffer is so important -- even at low interest rates.
2. Keep investing
Depending on where you are in your career, you may be better off letting your auto-deposits continue as they have been (this really refers to automatic 401(k) deposits taken from your paychecks). Assuming you have an adequate cash emergency fund, your best bet in a market downturn is to simply keep investing.
This allows you to buy more shares of stock at lower prices, and it allows your dividends to reinvest at those lower prices. Having a low average cost basis can lead to higher returns in the long run, especially if the stock market keeps making new all-time highs. It's often difficult for people to run toward the market when all we see is flashing red, but those who have the nerve to do it will almost certainly end up with better results after a period of years.
3. Pay down debt
If the stock market scares you -- or if you already have sufficient funds invested -- you might consider allocating new money to any outstanding debt, regardless of the interest rate. Paying down debt has a somewhat strange psychological effect, in that you'll likely feel instantly better the moment you do it.
It's financially accurate to say that you can borrow at low rates (think between 0% and 3%) to invest at higher rates and collect the spread. But in a market correction, you're not only losing money in your investment portfolio, but you might be in an even worse bind if you also owe money to creditors. Diverting any new money to debt repayment can help provide a feeling of control and freedom even when your investments are falling fast.
4. Look into I-bonds
When life gives you lemons, make lemonade. Given that inflation has come roaring back over the past year, I-bonds, or government-issued bonds indexed to the current rate of inflation, have become an attractive investment once again. I-bonds pay a rate of interest equal to the semi-annual inflation rate, plus a fixed rate determined by the market. For bonds issued in the current period, which runs from November 2021 to April 2022, I-bond rates are guaranteed at 7.12% for the first six months.
An individual is only allowed to purchase up to $10,000 worth of I-bonds in any given year, and if you want to buy them electronically, you'll need to create an account at TreasuryDirect, the government's bond sales site. Another important note is that I-bonds adjust their rates semi-annually, so if inflation were to fall back to earth, you may not earn as much interest as you initially anticipated.
Don't up-end your plan
No doubt, there are several things you can do to provide a greater feeling of peace during times of market turmoil. What you don't want to do is panic sell into cash, leaving your long-term plans in jeopardy. Take this time to exert some control over your portfolio but make sure it's all with the right intent.