The bull of Wall Street has shown stock investors its power, pushing the market to new record highs. Investors should be feeling pretty good. While I’m not one to be a party pooper, I am a promoter of preparation – especially when it comes to investing. It’s during rising markets that investors need to make sure they’re prepared for an inevitable downturn. The bull will succumb to the bear. It’s only a matter of when it occurs – not if. While it’s practically impossible to predict when the next bear market will bite, being ready for it can make all the difference. One of the greatest investors of all time, Sir John Templeton said, “Bull-markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” Mark Twain said, “History doesn’t repeat itself, but it often rhymes.” Putting those words of wisdom together may result in the current bull market ending on what past Federal Reserve chairman Alan Greenspan called “Irrational exuberance.” Though by no means am I as insightful as those three gentlemen, I think it is timely and prudent now to be prepared with a plan to protect your principal for the next bear market. Preparing for a bear market decline involves several strategies to protect your investments and potentially capitalize on opportunities. Here are seven prudent ways prepare to survive and thrive when the market trend turns from bearish to bullish, and hopefully provide proper perspective:
1 – Bear markets are normal. There have been 27 bear markets in the S&P 500 Index since 1928. However, there have also been 28 bull markets—and stocks have risen significantly over the long term. As the graph below shows, bear markets historically don’t last as long as bull markets, and they have gone down less than bull markets have gone up.
2 – Have a Plan. No investors intently say, “I am planning to fail.” But, those who fail to plan, plan to fail. This is particularly true in investing. Even speculating should be done with a plan. Sticking to a well-thought out plan will serve you well, because it protects yourself against emotional investing. It’s easy to panic when you see stocks falling, but that is rarely a wise move. Investors who panic to avoid the bear market ultimately suffer, because they aren’t invested when the next bull market comes around. I sign off on all my Market Monthly podcasts with my 6 P’s: proper portfolio planning promotes positive performance.
3 – Be Diversified. When the next bear market strikes, most of your stocks will probably go down. The good news is that with a diversified portfolio, your non-equity investments will help offset at least some of the decline. Diversification means to spread investments across different sectors, regions, and asset classes. This reduces risk exposure to any single market downturn.
4 – Keep cash. Cash reserves reduce investment portfolio risk, protect principal and rewards investors with about 5% interest. Ensure you have enough cash reserves or liquid assets to cover living expenses for at least 6 months. Or 1 year. This prevents you from having to sell stocks at depressed prices to meet cash needs. Cash is king in bear markets and your portfolio’s best defense. I like to say, “Sometimes your best offense is a good defense.” Especially true in bear markets.
5 – Avoid panic selling. Bear markets are temporary, and selling locks in losses. Ride out the downturn if you have a long investment horizon. Stay true to your plan and your rules-based investment process. The best question to ask is not “how is the market doing?”, but “how is my plan doing?”. Review your risk tolerance, goals, and asset allocation. Focus on diversification while minimizing concentration. If your portfolio cashflow is sufficient to meet your income needs and you own good businesses, why sell them? Do not panic. Avoid emotional decisions. Warren Buffett said, “You don’t want to be a no-emotion person in all of your life, but you definitely want to be a no-emotion person when making an investment or business decision.”
6 – Stay Informed. Keep current with relevant an timely global financial market and economic developments. By having an awareness of economic indicators, market trends, and geopolitical events that impact markets you will make informed decisions.
7 – Be Strategic. Effective ways to invest strategically include: set stop-loss orders. This will help you automatically sell if prices drop below a certain threshold. This helps limit potential losses. Have hedges. Non-correlated investments tend to trend opposite of the stock market. When the market zigs, these holdings zag. Other strategies are laddering bond portfolios and dollar-cost averaging. Don’t “bottom fish”. Be smarter than the bear.
All stock market investors enjoy up markets and like making profits. And, none feel good about down markets which bring declining stock values. The reality is Bull markets eventually change direction to become Bear markets and then Bear market periods turn more Bullish again, and the cycle repeats. Prepared investors protect profits from Bull markets and reduce the risk of Bear markets. The prudent and proven steps discussed above are a Guide to Surviving the next Bear market.
Again, my 6 P’s to investing are: Prudent Portfolio Planning Promotes Positive Performance. For a 7th P, be Prepared for the next Bear market.
I hope the checklist above is of value.
Call me if you have any questions. I am always happy to help!
John J. Gardner, CFP®, CPM®, AIF®
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