5 Tips For Dealing With A Bear Market
In light of the recent stock market decline, many people are wondering what they should do to survive the bear market. Large fluctuations in stock prices like the ones we experience during a bear market often cause investors to panic and act irrationally. However, I’m going to give you five tips to help weather the financial storm in your portfolio. Get ready to explore the history of bear markets and time-tested strategies used to come out on top during market declines. Click Here to listen to this instead.
Key Takeaways:
· What is a bear market?
· The importance of knowing your asset allocation
· Why you should have a diversified portfolio
· Don’t time the market
· Should I stop investing?
· The impact of having a financial advisor
What is a Bear Market?
The first thing to understand is what is a bear market? A bear market occurs when any of the five asset classes other than cash decline by 20% or more. The five asset classes include stocks, bonds, real estate, commodities, and cash. This decline could happen within a month, or it could take several, but once the decline hits 20% we know the bear market has begun.
If you are wondering how often bear markets occur, then let’s look at the recent past. There have been six bear markets since 1980, seven including the one that we are currently experiencing. To review, the bear market in 1980 led to a 27% decline in the S&P 500, the one in August of 1987 had a drawdown of 33%, and in July 1990 where the market fell about 20%. The more recent bear markets include the tech bubble burst that resulted in a 49% decline, followed by a 57% decline during the 2007 financial crisis, and lastly the most recent decline of 34% during the Covid-19 virus. Therefore, we can see that bear markets do happen a fair amount and the drawdowns vary based on the severity of the situation.
Now you may be wondering, how long does it take for the stock market to recover after a bear market? They widely vary as the Covid-19 bear market recovered in only 5 months while the recovery after the 2007 financial crisis took 49 months, and the correction in 2000 took 56 months. This measure calculates how long it took for the S&P 500 to get back to where it was before the bear market. Additionally, I will include a chart below that shows the drawdown and recovery of the most recent bear markets, a few of which were tied to recessions.
The Importance of Knowing Your Asset Allocation
My first tip for handling a large correction is to review your asset allocation. This is the mixture you have between the five main asset classes mentioned above. Digging a little deeper, it is the amount that you have in the growth-oriented assets such as stocks, real estate, and commodities versus the amount you have in capital preservation assets classes including bonds and cash. The larger the proportion of growth assets you have allows for greater potential gain and loss in your portfolio as these asset classes are known to be volatile. The money you have in bonds and cash provides limited growth and loss potential which is attractive to more conservative investors. You can also listen to: What is the Ideal Asset Allocation in Retirement?
Therefore, figuring out your exact asset allocation is important because you may find that you are invested more aggressively or conservatively than you once believed. In general, your 401(k) statement will have its invested allocation on one of the first pages. While other accounts may require you to calculate the allocation manually. This is a simple process, add up the nominal value of your equity accounts in the portfolio and divide it by the total amount in the portfolio. Then do the same for the bonds and cash you have in the portfolio. Repeat this process for all your investment accounts that do not display the allocation on the statement. You could add up your cumulative asset allocation from there to understand your current overall allocation and analyze whether you need to make any changes.
I looked over the 2008-2009 financial crisis because it was the largest-most recent decline that we have experienced with the S&P 500 shedding 56%. I have put together a chart of different asset allocations so you can see how much they declined during this 2008-2009 decline. For example, a 60% stock and 40% bond portfolio which is somewhat moderate, declined by 25% during that time frame. This was much less of a decline than if you have been invested 100% in the S&P 500, but it was still a significant decline and took a long time to recover your money. This is why it is crucial you understand the tradeoff between risk and reward and know the worst-case scenario for your asset allocation before a bear market occurs.
Why You Should Have A Diversified Portfolio
People often confuse diversification with asset allocation. However, they are different as diversification means to not put all your eggs in one basket and asset allocation means investing across multiple asset classes. Let’s say you plan to invest a portion of your money into large-cap stocks, you should not invest that money solely into Apple or only into tech stocks. This would leave you vulnerable to stock-specific risk in the case of Apple or sector-specific risk in the case of tech stocks. This would increase the amount of risk that your portfolio is subject to, which is unnecessary considering how easily it could be fixed through diversification.
For example, the technology sector was leading the market before the Covid-19 correction, but during the correction, it experienced the largest losses. All trends come to an end and can result in larger declines if your portfolio is heavily concentrated in one area or another. Sometimes individuals will benefit from investing heavily in one area, but it is important to understand that you may also experience greater losses by doing so.
An alternative to these investment strategies is to be diversified, where you have a broadly diversified portfolio instead of attempting to choose the best sector or companies within that sector. Investing in a portfolio of index funds instead will allow you to be diversified across all sectors of the stock market. Index funds will also be invested in many different stocks, so you will minimize company-specific risks such as lawsuits and bankruptcies. Instead, your portfolio is going to track the market which has proved to be the best long-term strategy. Even professional asset managers and hedge funds struggle to target which sector or group of stocks are going to outperform the market each year, so there is no reason to try to do this for your own accounts as mistakes can be costly.
Don’t Time The Market
One main objective you should have during a bear market is to maintain your perspective. You must understand that the media is there to sell you ads and other products. They often take advantage of scenarios where investors are nervous or overly optimistic to convince them to make irrational decisions such as getting out of the market or buying a certain stock to get rich. Channels such as CNBC or Fox Business are not there to help you with your investment portfolio, and they often have an agenda that they are trying to push. These channels attempt to predict the future, and as we have seen, that is easier said than done.
One issue with getting out of the stock market when stocks are headed down is that your entry and exit are extremely important. If you get out of the market late and then get back in too late, then you would have unnecessarily lost money. Remember, if you miss the best days in the market, then your returns over the long term will be significantly compromised. JP Morgan conducted a study looking at the S&P 500 performance over a 20-year period beginning January 1st, 2000, and ending December 31st, 2019. During that time the S&P 500 had an average annual return of 6%. However, if you missed the 10 best days of that 20-year period, your average annual return was cut to 3% per year. That is a 50% reduction in your return! This illustrates how difficult market timing can be and why it is so important to stay invested in the markets. Remember it’s time in the market that makes you money, not timing the market!
Another thing to consider is to not look at the statements for your investment accounts (assuming they are properly allocated and diversified) during a bear market. It can be overwhelming to see losses in your accounts month after month and could cause your brain to believe the investments are going to zero. However, if you are well diversified, you are never going to see your account go to zero. If you are invested in index funds, you are invested in hundreds and potentially thousands of companies, and you will not wake up one morning to learn that all those companies have gone bankrupt. Investing takes patience, and that patience will be tested when the markets decline. You must remind yourself of this and stick to your long-term plan and ignore the negative noise or your portfolio will likely suffer.
Should I Stop Investing?
One question I get during market declines is: should I stop investing in my 401(k), and wait for my investments to come back in value to resume investing in my 401(k)? My answer is: ABSOLUTELY NOT! The motto for successful investing is to buy low and sell high. Sounds pretty easy, but it isn’t. Therefore, you want to be buying stocks when they are in a decline or “on sale,” and that’s essentially what is going on during a bear market. If anything, buying more stocks during a bear market decline is one of the best courses of action that an investor can take because it allows for greater growth potential in the long run.
Depending on what market you are looking at, the S&P 500 or the NASDAQ, stocks are currently at a reduced price of anywhere between 20% and 30% from their all-time highs. Buying at these price levels is going to result in a much better deal than any stock you would have purchased six months ago when both indexes were flourishing. A useful strategy is called dollar cost averaging (DCA) which means investing a fixed dollar amount on a regular basis regardless of where the market is at. This strategy removes all emotion from the equation and should make you money as long as the stock market continues to have a long-term upward bias.
Let’s say you invest $1000 per month into your 401(k). With that fixed amount, you will be able to buy more shares in a bear market and fewer shares in a bull market. As I mentioned above, this fixed investment will take the emotions out of investing because no matter what the market is doing, your plan is still to invest $1000. That said, the shares you purchase during a bear market are going to significantly (and positively) impact your portfolio since it will lower your average cost per share. Therefore, dollar cost averaging can be a great strategy for an emotional investor because it takes a systemic approach and has proven to be successful in the long term.
The Benefit Of Having A Financial Advisor
My final tip would be to reach out to a financial advisor if you are unsure what to do, or worried about a particular aspect of your investment portfolio that you would like reviewed. It is easy to get overwhelmed when your portfolio is down or not performing how you anticipated. In these situations, it could be helpful to speak with a professional that can help you fix any issues with your portfolio or even just provide a sense of reassurance in times of uncertainty. An advisor can take an objective look at your portfolio (it’s not their money) and possibly improve your strategy or help with any financial planning concerns or needs you may have.
I hope this reading has helped you understand what a bear market is, and how to successfully navigate it. Bear markets are certainly not fun to go through. This one will eventually end but based on history is not the last time we will experience a bear market during our lifetime. The best thing for you to do is follow the tips above and try to stay calm. Understand that bear markets are going to help your portfolio in the long run because you gain access to discounted stock prices as you continue saving and you can lower your average purchase cost. The only way to truly lose during a bear market is to sell out your portfolio therefore locking in your losses or to stop investing throughout.
