The bears are coming…..The next bear market that is. And yes I am scared of bear markets but with a little preparation, we shouldn’t fear the bears.Actually, as a child (3 years old), I was terrified of bears. I would have recurring dreams, (that kind of dream that seems so real), where a family of cartoon bears would have a picnic on my front lawn. Through my bedroom window, they would beckon me outside to join them. But by that time they were waving me outside, I was running, Mach 1 to my mother’s bedroom. Maybe it was a harbinger of my passion for personal finance and the greater affinity I have for bulls over bears.
Side note: This post was published to coincide with Bear Weak. This is a clever take-off of the Shark Week theme. This ingenious idea was created by the blog My Sons Father to bring awareness to the idea that in spite of the last 9 plus years of stock market gains, the stock market does and will decline. Head on over to My Sons Father for some great content and funny pictures of talking Lego figures.
In the field of personal finance, there are terms and language that most people new to personal finance find confusing. Qualified vs. nonqualified, expense ratio, Roth, and exchange-traded funds to name a few. Bear and bull markets are two of those terms. I will attempt to get beyond the lingo. With 4 easy steps, I outline, you will come out of the next bear market stronger and more prepared to build wealth.
So what is a bear market anyway?
According to The Vanguard Group, “While there’s no agreed-upon definition of a bear market, one generally accepted measure is a price decline of 20% or more over at least a two-month period.
A Bull Market, on the other hand, is loosely defined as a 20% increase in the stock market that is characterized by optimism, confidence, and ultimately exuberance. Bull markets can last for months or years and ultimately die a tragic death. Bull markets tend to end with exuberance and an overvalued market that reverts to the mean in an often spectacular crash.
Oddly these terms derive from animal behaviors
The use of “bull” and “bear” to describe markets comes from the way the animals attack their opponents. A bull thrusts its horns up into the air, while a bear swipes its paws downward. These actions are metaphors for the movement of a market. If the trend is up, it’s a bull market. If the trend is down, it’s a bear market.
What kills a bull market? (Kiplinger Magazine)
- Higher inflation.
- Rising interest rates.
- Geopolitical instability.
I think that you can make a strong argument that 4 out of 5 of these situations exist today.
- Currently, the Federal Reserve Bank is in a cycle of raising interest rates to fight rising inflation.
- In the past couple of weeks, the possibility of a trade war with China has the markets spooked. A trade war could bring about a recession.
- The S&P 500 average price to earnings ratio is high for the current environment of rising interest rate environment.
- The US economy is not currently in a recession.
Yesterday was Friday, April 6th, 2018 let’s look at the markets at the close.
|point decline||% decline|
|Dow Jones Industrial Average||23,932.76||-572.46||-2.34%|
So with that kind of market decline, has the next bear market already started? Nobody knows. Should you sell everything and go to all cash? Probably not!
A bear market is a trend that can only be looked back upon. Predicting stock market behavior is a fool’s errand. So the best course of action is to prepare your finances and portfolio for the inevitable because it is not if a bear market will come but rather when.
4 steps to take before the next bear market
Step 1 Diversify.
One way to avoid huge portfolio losses is to diversify your investment portfolio. The extent to which you diversify is almost limitless. Precious metals, real estate, and crypto-currency to name a few. But for this situation, I am talking about making sure you have the right mix of stocks and bonds. One rule of thumb is to have your age (%) in bonds.
I like to use Age – 10 (%) in bonds
Example: I am 40 years old and I should have 30% in bonds.
These days I tend to recommend low-cost target date funds to those looking for a set it and forget it approach to diversification. Let’s face it. Most people don’t geek out of personal finance like I do.
One caveat is to make sure the fees are low. Not all target date funds are created equal. I recommend the Vanguard and Schwab families of target date funds. These two companies strive to keep fees low for their customers. The Schwab Target 2045 Index Fund, (SWYHX) has an expense ratio of 0.08%. The Vanguard Target Retirement 2045 Fund (VTIVX) has an expense ratio of 0.15%.
Step 2. Auto Rebalance
Set your portfolio to auto rebalance at least once per year. The action of auto-rebalancing takes money from some of your “winning” investments and moves it to some of you “losing” investments. This can set you up for major wins in the future by buying investments at rock bottom prices after a market decline.
In 2009 after the huge stock market declines, if your portfolio had rebalanced, by selling some bonds and buying some stock, you would be sitting on over a 300% return.
Step 3. Dollar Cost Averaging
This is probably the most important step. Do not, under no circumstance, stop your automatic investments into your Roth IRA or your employer’s 401k. There will be the temptation to stop your automatic investments or worse yet sell off your portfolio.
The constant media coverage of market declines will make it seem like the sky is falling. It is scary to watch your portfolio drop in value. It is difficult to put money into your 401k knowing that next week it could be worth less than it is today. Remember though, you are not investing for next week. You are investing for the next decade
Step 4. Do Nothing
Sometimes, when faced with indecision, the best course of action is do nothing. Liz from the blog Chief Mom Officer wrote a post titled the Ostrich Strategy. I really liked the simplicity of this strategy. It details the do-nothing approach to deal with tumultuous markets. When the market is in turmoil, the best action can be inaction. Give yourself and the stock market more time to spit out and digest additional information.
How many people sold out of the market after the 50% decline in 2009 to only watch the stock market appreciate over 300% in the next decade?
You and I are not smarter than the stock market. We will never be able to time market declines perfectly. On top of that, to time the market, you have to be right twice. You have to pick the perfect time to sell your stocks before a market decline and the perfect time to buy your stocks back before the market reverses and goes back up.
Remember that the emotion of these two market cycles is very important. Don’t find yourself following the crowd. During a bull market, there is exuberance. Everyone watches their portfolio grow. Every investment seems to be a winner and your taxi driver is giving you stock tips. But during a bear market, everyone is down and out. People toil over their portfolio declines, wishing they would have sold before the crash.
You are better off doing the opposite. Be a market contrarian. That is right! Here is my hot stock tip for you! When the market is declining, make some purchases. When your stock portfolio is hitting all-time highs, take some profits and rebalance.
The next bear market is coming, we just don’t know when. With these four steps, (diversification, auto-rebalance, dollar cost averaging and do nothing), I believe you will come out of the next stock market downturn better prepared to build long-term wealth.
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Here are some of my other posts you may like:
- 2017 Investing Lessons From Warren Buffet
- How to Spend Your Tax Return
- Start Your Financial Journey With These 4 Easy Wins
- March Mini Frugal Victories