Rick Rodgers, CFP®, is President of Rodgers & Associates in Lancaster, PA and author of “The New Three-Legged Stool™ A Tax Efficient Approach To Retirement”.
Many investors live in fear of severe drops in the stock market. They mistakenly believe that to be a successful investor, they must be out of the market when it drops. The stock market sell off that began in September 2008 sent many investors running for the sidelines in order to be in cash instead of incurring more losses. Some believed they made the right decision as the Dow Jones Industrial Average (DJIA) dipped below 7,000 in March 2009. But just like every other bear market in history, this market recovered much sooner and stronger than anyone expected. Those that sold their stocks while they were falling have now lost twice. They lost money when the market went down, and they lost again as it recovered while they were still holding cash.
Now that the market has stumbled these past couple of months, many people are wondering if a repeat of the 2008 market downturn is around the corner. Stock prices peaked on April 23rd of the year. The DJIA has dipped below 10,000 a couple of times since then. Is it time to get out before it’s too late?
The fact is that you will never know which direction the stock market is going to go next. No one will. Not me, Jim Cramer, Ben Bernanke or anyone else. The good news is that you don’t need to know to be successful financially. You need to put a strategy in place to help you take advantage of the run ups and sell offs in the market. A solid strategy determines how much of your assets should be in equities to provide the growth you need to reach your goals. The rest of your assets are invested in fixed assets that preserve your principle during bear markets. The hard part is to have the tenacity to stick to the strategy and the faith to believe it’s the right thing to do. That’s not easy during bear markets.
Investing in the markets is not “gambling”—unfortunately it is still viewed this way, mainly due to media misinformation. The ultimate goal of the financial press isn’t to help you become financially secure and independent. The financial press wants you trading, chasing hot trends, and jumping in and out of the markets, so you will continue to consume more financial press.
Financial security and independence is built over a lifetime by following a few simple rules, staying focused on your goals rather than on the markets and not getting scared out of equities during bear markets.
Since the end of the World War II, there have been 13 bear markets including the most recent drop in 2008-2009. This averages out to one in every five years. Bear markets are common. There is nothing unusual about them and we should embrace them. It is a time when the markets ring out the excesses brought about by speculation in one sector or another. This is the time to implement your strategy by rebalancing from fixed assets to equities. Your strategy allows you to buy low because the value of the equities has shrunk and you now have too much money in fixed investments. When the markets are going up, this same strategy tells you to sell high because you are over weighted in equities. Harvesting off the excess gains preserves them so you will be ready for the next bear market.
Here are five things you can do when the market turns bearish:
- Embrace volatility - You will never now when the market is going to drop and neither will anyone else. Corrections in the market like we are having today are inevitable and should be treated as opportunities. Stop kicking yourself for not reading the tea leaves correctly.
- Rebalance your portfolio – Everyone will be over weighted in fixed income now that their stocks have shrunk. It is time to sell fixed investments and buy equities to get back in balance.
- Pull your weeds – Get rid of underperforming positions that you may have been reluctant to sell because of the tax implication. Upgrade you investment portfolio while prices are down.
- Harvest losses in taxable accounts – You may be thinking you already have plenty of losses and you can only take $3,000 each year on your tax return. But loss carry forwards never expire and you will be glad you have them when the market recovers.
- Get a second opinion – Hire a professional adviser to review your investment strategy and current holdings. Ask them specific recommendations and the reason for making them. It is always a good idea to have a fresh set of eyes critique your strategy.
During the later stages of a bear market, investors tend to be dragged down by despair, so they sell the good and the bad together. While we would all like to think we know precisely the time to sell and buy, those times are emotionally counter-intuitive. The fact remains that in order to grow real wealth; one has to stay invested, and continue to own the great companies of this country. The great investor, Warren Buffet, wrote in his op-ed piece to the New York Times on October 17, 2008 “A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful.” He concluded the article with this paragraph, “I don’t like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I’ll follow the lead of a restaurant that opened in an empty bank building and then advertised: “Put your mouth where your money was.” Today my money and my mouth both say equities.” The DJIA closed the day this article was printed at 8,852. Today it is back over 10,000. Warren Buffet embraces the bear and so should you.
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