Stock Investors' Handbook for a Bear Market

For a cheap, do-it-yourself hedging strategy against a dip in the stock market, options can do the trick. This recommendation comes from Rick Hassan, a financial advisor with Alex Brown, a division of Raymond James Financial Inc. (RJF) that deals with high net worth individuals. "It feels good when the market is down 20%, and you're down 8% or 9%," he tells Barron's.

Hassan's book of business includes 385 households with a typical account size of $48 million. He and his Greenwich-based team of four manage $2.5 billion of client assets, and he is Barron's fifth-ranked advisor in Connecticut. Barron's adds that 90% of his clients are so wealthy that they never need to touch their investment principal.

The Strategy

Hassan's model asset allocation, per Barron's: 50% stocks, split 60/40 between growth and value; 20% municipal bonds; and 30% alternatives, split 80/20 between hedged equity and structured products. He does not believe in active trading because of the fees and taxes. He prefers, instead, to find quality stocks to own for the long pull. He has reduced his clients' bond holdings in recent years, and he finds that only municipals have a sufficiently attractive tradeoff between yield and risk, particularly for his high income tax bracket clients.

Hassan's clients are big enough that he designs customized structured products for them, shopping around for banks who will give him the best deal. These products typically offer up to 50% downside protection, and unlimited upside participation, in exchange for an annual fee that averages 0.6% of invested assets.

As far as the hedged equity portion of his model portfolio goes, Hassan uses publicly traded put and call options on the S&P 500 Index (SPX). The average annual cost of this hedging is 1% of invested assets, Barron's says. Bank of America Merrill Lynch, a division of Bank of America Corp. (BAC), also has outlined a hedging strategy using S&P 500 options. (For more, see also: How To Hedge Against A Stock Market Plunge: Bank of America.)

Disciplined Redeployment

Jan Loeys, chief investment strategist at JPMorgan Chase & Co. (JPM), advises taking profits on a regular basis from risky positions, and shifting the proceeds into defensive investments, according to The Wall Street Journal. More specifically, he suggests cashing out of some high-flying technology stocks each month, then reinvesting in less expensive stocks and U.S. Treasury Bonds. This gradualist approach, in his opinion, avoids the problems with the two extreme alternatives. Those who stay fully invested will never be able to reach the exits in time when the inevitable downturn comes. Those who sat on cash and bonds while stocks zoomed upward, meanwhile, missed out on some spectacular gains that are not likely to be repeated anytime soon.

Other Defensive Moves

In recent weeks, Investopedia has profiled several other defensive strategies. One involves moving your equity allocation into higher-quality companies, while also diversifying internationally and regionally. (For more, see also: How To 'De-Risk' Your Stock Portfolio For A Crash.)

A study by the Financial Times found that, in the last bear market, stocks with high returns on invested capital (ROIC) were prominent among those that actually registered gains. (For more, see also: Which Stocks May Outperform in the Next Market Crash.)

Strategist Michael Belkin correctly forecasted the onset of the last two bear markets, and he recommends some cheaply valued, dividend-paying defensive stocks, as well as some short-selling candidates. (For more, see also: The Apocalypse Stock Portfolio: One Strategist's Picks.)

Bank of America Merrill Lynch expects that banking and healthcare stocks can ride out the storm, if the market declines. (For more, see also: 2 Big Safe Havens if the Stock Rally Crashes.)