Nobody likes a bear market, or any correction for that matter. They can feel terrible and as if they are never going to end. Human beings are inherently optimistic creatures but prefer it when the environment is stable and things are going well. A nice upwardly trending market with little to no volatility is what makes us smile.
There is a volatile side to human nature as well. We can get overly pessimistic at times. When we do we tend to act irrationally. It is during these pessimistic periods where the vast majority of investing mistakes are made.
Before you pull the trigger on selling all your stocks during a correction or bear market I’ve come up with some points to consider and an important investing tool to helping you avoid making a mistake.
#1) Bears are short, Bulls are long.
Since 1926 the average Bull Market has lasted 9.1 years and returned an average of 480%. The average Bear Market has lasted just 1.4 years and had an average loss of 41%. First Trust has a great chart to display this if you’re visually inclined (click here to view). The point to think about as you look at this chart is that bear markets and corrections do happen occasionally in markets. More importantly, sometimes a recession can happen that does not even drive the markets into a “Bear Market”. In fact, as I look at this chart I can see 15 recessions but only 8 bear markets. Furthermore, three of those eight bear markets lasted 6 months or less and resulted in “only” about -20% to -30% returns.
My advice: Depending on your time horizon, it is best to suffer the short (but often aggressive) downside to make sure you are there for the long (often boring) upside.
#2) Cyclical bear markets act differently in a secular bull market than in a secular bear market.
Some of you may be familiar with our work on market cycles. Go back and read it to learn about what I mean when I say “secular”. It is an important term to understand if you are a long term investor.
The short of it is that a “bear market” that occurs in a longer term secular bull market (like we have today) is much softer and shorter. I know it doesn’t feel that way when stocks are falling out of the sky but history has shown it to be true.
My advice: It is so important to not make mistakes when you are in a bear market. It could end faster than you think.
#3) Successful Investors generally ignore forecasts and predictions.
You will never hear me tell you what I think is going to happen. That is because most people pose this question with a recency bias. They want to know what is going to happen this week, next week or next month or even this year. It is impossible to know the right answer with a certain degree of consistency and precision. However, we are bombarded daily with people who claim to know the answers. CXO Advisory Group ran a great study that looked at 6,582 investment predictions on the S&P 500 from 68 different investing “gurus” made between 1998 and 2012. The study examined the results of their predictions. There were some very well-known names in the group, yet the average guru accuracy was just 47% – less than half were right. Furthermore, of the 68 gurus, 42 had accuracy scores below 50%! So not only was the average score for the group bad, the majority of the “gurus” themselves were inaccurate.
Humans have a tendency to take recent events and forecast similar results into the future. Researchers have also examined stock picks from other supposed market gurus and the results are even more off base.
My advice: It is best to avoid the forecasts and predictions. Especially short term ones or ones when the predictor is 100% sure. “Death and taxes” are the only things we can be sure of.
#4) The financial news outlets are self-fulfilling.
When the markets are up they find quotes from “smart” people that are bullish. When the markets are down they find quotes from “smart” people that are bearish. Many of these “smart” people have been bullish or bearish for years before the actual Bull or Bear arrives. In a bear market they are usually from a firm you’ve never heard of. Read the data in #3 above if you think you should listen to them.
My advice: Avoid the news outlets especially in a bear market. They’re only looking to increase eyeballs and advertising revenues, at your expense.
#5) Timing the market is a fools game.
Trying to pick the right day to “get out” or “get in” is nearly impossible. The probabilities of you being right are stacked against you. Furthermore, you have to be 100% correct TWICE. Once when you get out (in) and a second time when you get back in (out). Almost impossible. Don’t ask us how many people we’ve spoken to that got out near the market bottom in 2009 and are STILL not fully invested back in. They have missed one of the greatest bull markets in decades. Look below. Studies have shown that missing the 10 best days over a 20 year period reduced your returns by an average annual 3.67%. Doesn’t sound like a lot? Over 20 years $100,000 fully invested at an average annual rate of 7.2% would have grown to slightly more than $400,000. Miss those 10 days and it would have only grown to slightly more than $200,000. 10 days costs you $200,000!
My advice: Don’t try to time the markets.
#6) Asset allocation is SO important.
If you are a client of Shorepine Wealth Management you’ll be very familiar with our work on ensuring your accounts are allocated correctly. That is because a correct asset allocation will place your investments in an overall portfolio that takes into account your risk profile (fear of loss), your needs in retirement (required return) and any unique circumstances you may have. More importantly, a correct allocation will soften the blow of these negative environments. And that is what can stop you from making the mistakes we site above.
In the fourth quarter the S&P 500 was down almost 15%. A typical 60/40 (60% Equities / 40% Bonds) portfolio was down significantly less than that. Like almost half less than that!
My advice: Make sure you are allocated according to your ability to handle risk, your needs and your unique circumstances.
(P.S.: I can help with that.)
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