The first rule of bear markets: DON’T PANIC!
Why? Remember these rules:
- Bear markets often sting, but more importantly, the sting is short-lived.
- Bull markets take longer to play out, but more often than not, reward those investors that stay invested.
THE BOTTOM LINE: The recovery from the bear market is often very swift. Anyone sitting on the sidelines is hurting themselves.
The Great Recession of 2008 offers important lessons to all investors on how NOT to react to a bear market. The millions of investors who fled at the bottom of the market then waited for a full recovery to re-enter learned how painfully slow it can take to return to normalcy.
Take, for instance, the following:
EXAMPLE:
Pre-Bear Market – ($4 share price of Company X)
Investors #1 and #2 have 25,000 shares in Company X
Portfolio Value:
Investor #1: $100,000
Investor #2: $100,000
Bear Market – ($2 share price of Company X)
Investor #1 doesn’t panic and stays in. Investor #2 panics and cashes out.
Portfolio Value:
Investor #1: $50,000
Investor #2: $50,000
Beginning of Recovery – ($3 share price of Company X)
Because Investor #2 is on the sidelines, his portfolio does not begin to recover like Investor #1’s portfolio.
Portfolio Value:
Investor #1: $75,000
Investor #2: $50,000
Full Recovery – ($4 share price of Company X)
Investor #2 decides to re-enter the market, but because he cashed out at the bottom of the market, he has only $50,000 to invest. At $4 per share, he is only able to buy 12,500 shares, whereas the pre-bear market, he owned 25,000 shares at $4 per share. Investor #1 still owns 25,000 shares, twice as many shares as Investor #2.
Portfolio Value:
Investor #1: $100,000
Investor #2: $50,000
Bull Market – ($8 share price of Company X)
Because Investor #2 bailed at the bottom of the market and didn’t re-enter until a full recovery, he doesn’t benefit from the bull market as Investor #1 does. Because Investor #2 only owns 12,500 shares, half the shares of Investor #1. Investor #1’s portfolio is now double its pre-bear market value. Investor #2 has merely returned to his pre-bear market level.
Portfolio Value:
Investor #1: $200,000
Investor #2: $100,000
LESSON LEARNED: Some may think this example is far-fetched, but this is exactly what happened in the aftermath of the Great Recession.
In March 2019, the market hit rock bottom, having lost more than half its value from its previous pre-bear market high (October 2017).
Those who cashed out at the bottom of the crash in March 2009 then waited for a full recovery, which occurred in February 2013, would have waited until February 2020 to fully recover the previous value of their portfolios.
THAT’S A FULL 11 YEARS!
Those who stayed in? They only had to wait four years when in February 2013, the market had returned to its pre-bear market high. Those who stayed in would have doubled their portfolios by February 2020.
Don’t panic in a bear market.
History has taught us that bear markets are short-lived. And if you cash out, put that money to work immediately!
Even as the stock market recovers in a bear market, so does the rest of the economy. Putting that cash to work in a productive asset that cash flows may very well reward you with returns that exceed the returns from staying in the market as it enters the bull territory.
Smart investors who decide to get off the Wall Street roller coaster will immediately put their cash to use in the private markets that will grow at equal or greater rates than the broader market but shielded from future bear markets.
What are the dos and don’ts of a bear market?
- Don’t panic.
- Don’t sit on cash.
- If you cash out, put the cash to work immediately.
- Don’t put yourself in this predicament again by seeking cash-flowing assets to carry you through downturns.
- Look to alternative assets shielded from future bear markets.