In the previous whitepaper, we discussed determining the margin of safety of your holdings, which can reduce risk and improve return simultaneously. In this whitepaper, we will examine the last task for surviving the bear market: planning with a financial advisor.
Diversification
Investors must plan their asset allocation thoroughly with a professional advisor. The first thing on the table is to ensure that your holdings are sufficiently diversified across asset classes and then within an asset class. Through diversification, one can mitigate unsystematic risk, which is a risk that is associated with a single company or single industry. For example, an investor whose portfolio solely focuses on airline stocks would’ve lost most of his money during the pandemic. However, suppose he decides to diversify his portfolio and build some positions in tech, medical care, and semiconductors. In that case, he may still lose some money but will be in a much better situation. Therefore, it is crucial for investors to have a diversified portfolio during the bear market.
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Leveraged Positions
The second item on the checklist is to identify any high leverage positions. When the market is rising, having high leverage positions can lead to lucrative profits. Conversely, in a bearish market, high leverage positions face the risk of forced liquidation, which happens when investors fail to meet the margin call. In the current market, volatility in the foreseeable future would likely increase, which means if the market continues to decline, your positions can be wiped out completely. Therefore, leveraged positions are extremely dangerous, should be handled by financial advisors, and should be avoided if possible in our view.
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Holding Period
The next thing to be discussed is your holding period. For many investors looking to retire, their holding period may only be a year or two. For others who just started investing, their holding period can be decades. Investors near their retirement may have to sell their stocks in a bear market, which is the worst thing to do. Investors in this situation shouldn’t panic but thoroughly prepare for capital allocation with their financial advisor. Investors whose period is more than five years should treat this bear market as a bargain. As mentioned in the previous whitepaper, many tech stocks have taken an unfair beating in the current market correction due to mass psychology. Investors are moving their positions from tech to other sectors like energy because everyone else is selling their positions in tech, scaring away more investors. Nevertheless, many of these tech stocks have not changed in any way fundamentally. Investors should prepare a strategy with financial advisors for buying cheap and high-quality stocks like this.
Liquidity
Liquidity is another important matter to be discussed. Investors should figure out whether or not they need large amounts of cash in the upcoming future for events such as a wedding or home purchase. If investors have insufficient liquidity, they need to first stop investing more money into the stock market, and perhaps move to safer short-term instruments like T-bills. Last thing that investors would want is to be forced to sell their stocks in a bear market.
Strategy
After all of the above factors are taken into account with a financial advisor, investors should then have an answer to their strategy: defensive or aggressive. For those that have a short holding period and need liquidity, they need to be defensive. The average bear market has a 16-month duration. Unless investors can wait that long, they have to be defensive with cash instead of “buying the dip”. However, if you already have sufficient liquidity and a long time horizon, you are getting a bargain at the market’s current price, which means you can be aggressive. Buying in the declines often led to good results historically speaking. The average 12-month return after the end of a bear market is 43.4% while the average stock market return is about 10% per year. If one decides to be aggressive, there can be great returns coming out of the bear market. However, investors must discuss the exact strategy with their financial advisors before attempting to size up their positions.
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In conclusion, investors should plan their strategy with their financial advisors after examining the following tasks: diversification and leveraged positions within their holdings, holding period, and needs for liquidity. After all, if your portfolio has been severely affected by the bear market, do not panic. Read our previous whitepaper on the market’s recovery after a crisis.
By Siddharth Singhai
Disclaimer:
This White Paper expresses the views of the author as of the date indicated and such views are subject to change without notice. Ironhold Capital has no duty or obligation to update the information contained herein. Further, Ironhold makes no representation, and it should not be assumed that past investment performance is an indication of future results. Moreover, wherever there is the potential for profit there is also the possibility of loss.
This White Paper is being made available for educational purposes only and should not be used for any other purpose. The information contained herein does not constitute and should not be construed as an offering of advisory services or an offer to sell or solicitation to buy any securities or related financial instruments in any jurisdiction. Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third-party sources. Ironhold Capital Fund 1, L.P. (“Ironhold”) believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based.
