It’s a question that’s speculated upon almost daily by the financial media — when will the current bull market end? And while I don’t claim to have the answer to that question, what we do know is that it’s been over six years since the last recession, and historically (at least since 1950), they come on average once every five years. So we know it’s coming, we just don’t know when.
A recent WSJ article by Jim Browning addresses this question, and points out that the best way to prepare for this inevitable event is “not the way you think.”
“The biggest mistake ordinary investors make, aside from not saving enough, is trying to time the market.”
The trouble with timing is that no one actually knows how to do it. When you go back through history and look at long bull runs like we are having today, even Wall Street veterans have often been surprised by how long it continues. Even when stocks were grossly over-valued (which, by the way, they aren’t now) as they were back in 1997, it took another three years before the bear market came calling.
“People who change their holdings because they see a bear market coming almost always lose out. The average investor in stock mutual funds made 3.8% a year over the past 30 years, according to Boston research firm Dalbar Inc. That is one-third of the S&P 500’s average 11.1% gain in that period. Dalbar’s explanation for this sad performance: People buy and sell funds at all the wrong times.”
This tendency to buy and sell at the wrong time is built into our human nature. That’s why knowing your own risk tolerance and having a well-diversified portfolio in line with it is so important. Mr. Browning refers to a study done by professor Terrance Odean of Harvard, an expert in investor psychology.
“Prof. Odean’s studies have shown that people buy and sell stocks at the wrong times. They sell stocks that are poised to rise and buy stocks that do worse than those they sold. ‘They did worse than if they had been throwing darts,’ Prof. Odean said after completing one study.
This is the problem people have preparing for a bear market. They aren’t good at picking the top, and they panic and sell once stocks have fallen heavily, when they should be buying.
Even people who get out before a bear market often shoot themselves in the foot: They are too frightened to get back in and miss the rebound.”
So the risk of a coming bear market is actually less of a real risk to your long-term success. The real risk is forfeiting the long-term returns necessary to meet your goals.
“Instead of tinkering with their holdings, financial planners and academics say, people should build all-weather portfolios of stocks, bonds, cash and other items that can rise in good markets and limit declines in bad ones. Then they might find themselves actually embracing bear markets as opportunities to buy stocks at discounts.”
This is especially true to those who are still in the pre-retirement or savings phase of life.
“People who contribute regularly to funds and don’t need the money soon should celebrate when stocks fall 30% or 40%. Their regular purchases now buy stocks at a discount, and history shows that broad markets always rebound. Over time, they are ahead.
Instead of selling, people should redouble their buying after a big drop. Easy to say. Hard to do.”
So what do we do to survive a bear market? It’s an easy answer, but hard to implement: we simply have a plan in place ahead of time, and then the bear comes, we look for the opportunities that are unearthed in the aftermath. In other words, there’s two steps to the process: first, we have to stay disciplined and diversified going in, and not succumb to the temptation to try to time the market. Second, when the inevitable slowdown does come, we wait for the dust to settle, and then we look for asset classes that are undervalued (e.g. that have been unfairly punished by the massive amounts of fear that pervades any bear market). That’s the recipe for long-term success in the world of investing.