I have made it clear that I am an optimist and wouldn’t dare bet against the stock market. Although there have been many pessimists predicting the reverse, I strongly believe that stocks will rise and the world won’t end. I think American businesses will continue to provide value to consumers and technology will allow companies to gain efficiencies which will ultimately be passed onto investors in the way of profits.
Interestingly, this article was originally published in September of 2012 and since then (as of Sept 9, 2018), the S&P 500 has earned an impressive total return of 101% which equates to just over a 12% average annual return.
All in all, stock market returns have been good. Maybe too good.
How Can I Bet Against the Stock Market?
After 9 years or so of mostly up and to the right growth, many people are forgetting that losing money in stocks is even a possibility – which is scary.
As a contrarian investor, it may be time for you to get out – especially if you think the positivity is artificial and has been fueled by an easy and accommodating monetary policy.
So let’s say this is your mindset. How can you benefit from your instincts predicting a market decline?
You could sell everything to lock in your gains – OR – you could try to profit even more.
Here are the most common ways of betting against a stock market decline:
Pay Down Debt
While it’s not necessarily an “investing strategy,” paying down debt is one of the safest “investments” you can make. It can often times make sense to hold onto debt with a low interest rate in order to earn higher returns, but there’s nothing wrong with accepting a guaranteed return of 3-5%.
Rebalance Your Portfolio
As an investor, it’s important to choose an asset allocation. The most common asset allocation is between stocks and bonds, but can also include real estate, mortgage-backed securities, precious metals and more. Over time, one asset class is always going to outperform the others and it becomes very tempting to move all of your money to the best performing asset. Unfortunately, this is the worst thing you can do because last year’s winner is often this year’s loser.
To save yourself, rebalancing your portfolio once a year is a great idea. If you started with 80% stocks and 20% bonds and your current allocation is 90% stocks and 10% bonds because stocks have performed so well, it’s a great idea to bring your distribution back to 80/20. This strategy ensures you’re selling high and buying low.
Put Options
With a put option, you pay for the right (not obligation) to sell a specific stock at a specific price within a specific time frame. For example, if I think Amazon (trading 300x forward earnings) is going to go down, I could buy a Put Option that expires this month, next month, next year, or in a few years.
Shorting a Stock
I would only recommend this to less than 1% of investors. It can be both complex and risky. I’ll try to simplify it for you…
You borrow a stock. You sell the stock. Since the stock you sold is borrowed, you promise to buy the stock later to in order to repay your debt. If the stock went down, you may have sold it for $20 and bought it back for $15.
Khan Academy probably has the best video tutorial on shorting stock.
Inverse ETF’s
Inverse Exchange Traded Funds are extremely simple (unlike the above options). You can use them as a hedge or if you want to bet against the market. They differ from shorting and put options because they don’t involve individual stocks. Instead you can focus on the entire market or a specific index or commodity. Example: remember when Gold was skyrocketing and you knew it had nowhere to go but down? Depending on how confident you are, you can bet 1x, 2x or 3x the movements.
Invest wisely.
Readers: Do you have any additional tips on ways to bet against the stock market?
[…] Blinkin @ Funancials writes How Can I Bet Against the Stock Market? – How to bet against the stock market with put options, shorting stock and inverse […]