For investors, bear markets (a stock market decline of 20% or more) are obviously very unpleasant. However, through history they are a regular and recurring feature of the market landscape. As I write this piece on the morning of January 24th, the S&P 500 Index is off to its worst start of a year on record: down 11% in the first 16 trading days of the year. Is a bear market coming in 2022? We don’t know, and neither does anyone else. No one knows the future path of markets.
If a bear market should come, however, the most important thing for investors to do is not make big mistakes. The classic mistake, of course, is selling most or all of one’s stocks during a downturn and sitting in cash while markets are bouncing back. Once the market has left the station without you, it is very difficult to catch up.
Many people think the way to long-term investment success is to somehow avoid downturns. But our Cardinal Rule of Successful Investing is this: You must be in the market when it goes up! Thus, it is okay (but not pleasant) to be in the market when it goes down, but it is not okay to be out of the market when it goes up. Here’s the logic: the market has recovered from every single downturn in history (except the one we are in now). Thus, all previous downturns have, in retrospect, been buying opportunities. However, if your portfolio is sitting in cash when the market bounces, say, 10% before you reinvest, then you have lost out on that 10% move permanently.
Here are a few things investors can do to help them weather the storm in today’s markets:
- Take a Breath. Many downturns have an “end of days” feel to them. Don’t buy into the negativism. Every downturn in the history of U.S. equity markets has subsequently repaired itself. The cure, in all cases, was time.
- Don’t Overreact. If the recent volatility has been a little much for you, consider modifying your asset allocation after things improve so that subsequent downturns do not jostle your portfolio as much.
- Upgrade Your Investment Holdings. Probably 99% of funds are not worth owning. They are too expensive, too tax-inefficient, or carry too much risk. With assets down across the board, there may be an opportunity to swap weaker funds or stocks for better ones with little or no tax impact.
- Small Concrete Actions. Do a few small things to incrementally fortify your financial position. No one knows what markets will do next. However, it is a fact that U.S. stocks are 11% cheaper than they were just a few weeks ago. If your situation permits, do a little shopping while assets are on sale. Here are examples of a few actions to consider in order to take advantage of the pullback.
- Rebalance your portfolio to your target weights.
- Contribute money to your IRA and or 401(k) for the current tax year and invest it.
- Make your full contribution to your Health Savings Account, if you have one, right now. Then invest the funds.
- Have 529 Plans for your kids? Downturns are a great time to make contributions.
Remember, in the history of markets, money put to work during down markets has had a higher subsequent rate of return than money put to work during buoyant market.
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