E:28 How to take advantage of a bear market
What to do when the stock market just flat stinks.
I know the feeling…You log into your account, hold your breath, and see that the account value has slipped even more. It has been months of seeing scary headlines and watching the value of your portfolio, EVERYTHING you have worked for, just slipping further and further in the wrong direction. You are starting to think that this will never turn around. I mean it has been over half a year of destruction and maybe just getting out would be better than having to watch it fall even more.
If you have had this experience, you are not alone! It is quite a common reaction from investors when the market falls more than 20% and slips into a “Bear market.” Since 1928 investors have had this internal battle with themselves 26 times, or once every 3.5 years or so.
How you handle these moments in the market can have profound impacts on how successful you will be as an investor. Making the wrong move at the wrong time can set you on a path of realizing the losses and regret. The big problem? Your emotions always advise you to make the wrong decision when it can hurt you the most. So…what do the best investors do when the market slips into freefall and the future looks bleak? They find the opportunities and take advantage of them!
Controlling Your Emotions and Understand the Fundamentals.
The first thing you need to do is be able to control your emotions, or work with someone who is not emotionally attached to your money. The market goes up and the market goes down, it is just how it is, and your emotions want to keep riding the wave when it is going up and it makes you want to jump overboard when it goes down. The issue for investors is it is almost impossible to tell when it will go up or go down, so we need to focus on what we do know; over the long run it goes up. Trying to time the market will almost always lead to locking in losses and missing the recoveries.
Half of the strongest days in the past 20 years of the S&P 500 have happened during a bear market. If you let your emotions win and you bail when the market falls, you miss those gains forever and prolong your asset’s recovery. While there have been 26 bear markets since 1928, there have also been 27 (much longer) bull markets.
Always remember that every single bear market up to this point HAS recovered. Be wary of your emotions and understand that the market is a tool that moves money from the impatient to the patient…you do not want to be the former.
Look for Opportunities.
If you have some cash on the sideline, these market dips are enormous opportunities for you. Being able to invest in the market when it is down 20%-30% has proven to be a fantastic way to generate wealth. However, do not fall into the emotional trap and try to time the bottom, you likely will not get it right. Instead take a step back and see things 5-6 years down the road. Investing when the market is down 25% will still be an extremely attractive entry point, even if it falls to 30% in the short term, and it will always be better than if the market were to rally before you were able to invest.
If you do want to mitigate some of the risk of getting money into the market, you could use a dollar cost averaging strategy. This is when you select a percentage of your money to invest and get it in the market over regular intervals. Maybe you put 20% of your money in the market every month for the next 5 months. This will protect you from having the market fall right after you put all your money in, and it will give you the ability to invest a larger percentage if the market does tumble to cheaper valuations.
Roth Conversions and other Investment Strategies.
If you are already in the market, this is a good time to take advantage of some tax loss harvesting and other tax strategies like a Roth Conversion. The idea here is that if your IRA falls a significant amount through the market turmoil, you can take some of that IRA (pay your taxes on it) and convert it into a Roth IRA. This way, when the rally does inevitably happen, all your gains will be tax free. See, bear markets can be fun too!
Additionally, spend some time rebalancing your portfolio. Right now, the equity portion of your portfolio is probably getting smaller and smaller. That means if you were in a 60/40 portfolio (60% stock and 40% bond), you may be closer to a 40/60 portfolio today. If that is not what your investing strategy is planning, you are going to want to make sure to rebalance and get your percentages back on the right track. Keeping your correct stock exposure will help the portfolio recover faster when the market starts its climb back up.
Do not stop investing.
“Should I stop my 401k or IRA contributions while the market is going down?” This is a common response from investors when their emotions start rearing their head. The answer is simply, no! For the same reason that getting money into the market at lower valuations makes sense for those sitting in cash, continuing to contribute through downturns allows you to keep buying into the market for cheap and will aid a larger recovery for your portfolio. If you have the means to continue contributing it can be the best thing you do through these periods.
I honestly believe one of the most valuable things I can do for a client is help them through down markets. Just being able to help them avoid the mistakes that most people make when the market just stinks can make all the difference. However, I get it. I am human too and no one likes to see the value of their account fall. We just need to go back to the fundamentals, look at how these things have played out historically and have a clear mind when opportunities do arise.
I will leave you with these quotes from one of the most successful investors of our time, Warren Buffett.
“Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold.”
- Warren Buffett 2016
“The sillier the market’s behavior, the greater the opportunity for the businesslike investor.”
- Warren Buffett 2003
“Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”
- Warren Buffett 2008
DISCLAIMER: The foregoing content reflects the opinions of Penobscot Financial Advisors and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security.