For most equity investors, a secular bear market is something to fear. It can represent massive unrealized losses, a significant reduction of paper wealth, and a gradual vanishing of value that took months to build.
Aside from the battering that your portfolio undergoes, the truth is that the fear of losses–never knowing how deep it may go, or how long it may continue–is often worse than the event itself. How so? Just take a look at the average performance of the S&P 500 since the 1940s:
Average bear market decline is a little over -30%, lasting (on average) a year and four months.
Average bull market rise is nearly 150%, lasting on average four years and nine months!
This means that if you are well diversified, and dollar cost averaging during each bear, you would have come out well ahead after each bull/bear market cycle. Hence, the fear has historically been worse than the reality.
For some equity investors, a secular bear market is an opportunity to exploit. If you believe that a bear market is a natural part of the business cycle, and if you believe that the U.S. economy will remain one of the strongest economies across the globe, then a bear market represents an opportunity to cultivate financial growth.
You can do this one one of three ways: the first way is to continue dollar cost averaging; the second, is to hedge your portfolio by seeking to generate gains on the downside (i.e. going short the market); and the third way is to hedge while converting those downside gains into more dollar cost averaging.
Well talk about the second, hedging your portfolio, as it is something that many investors can easily misunderstand.
Hedging a Bear Market
Lets address the big caveat: you