Spend From Your Winners
The financial media is always warning about the next “bear market” and how scary and horrible it is going to be. This constant negative rhetoric is good for clicks, but bad for individual investors' emotional health. Let’s talk about what a bear market really is, what you can do to stop worrying about it and how investors can better prepare instead.
A bear market is a prolonged decline in the stock market. It is most commonly defined as a 20% decline from peak stock market price. Smaller declines of 10-20% are called “corrections” and are more common than a full “bear market.”
From 2000 to 2019 a correction occurred in 11 out of 20 years, or 55% of the time. Since 1928 there have been 26 bear markets in the S&P 500 (the top 500 public companies in the United States), that is one every 3 and a half years.
Believe it or not, bear markets and corrections are a normal, expected part of investing. No bull market can last forever, so it’s better to prepare for bear markets than to try and predict when they will happen.
Source: Invesco, Bloomberg L.P. Returns from 11/29/68–12/31/20.
Here are 3 ways to prepare yourself and your portfolio for the next bear market:
1) Have Enough Saved
We recommend that all of our clients have 6-12 months of living expenses in cash. Sometimes (but not always) bear markets occur alongside recessions and a poor economy. If you lose your job during a bear market, you're going to have to tap into your reserves -- ideally you will have cash saved up that you can go to before your investments. Your investments should be your last resort, especially during a bear market. Having some extra cash allows yourself the flexibility to get back onto your feet without having to sell your investments and eat a 20-40% loss. Furthermore, having cash on hand allows investors to be on offense and put that cash to work in order to take advantage of upswings.
2) Optimize your portfolio for your goals
Your portfolio should match your risk tolerance and goals. If you are going to retire in 5 years you should not have all of your investments in stocks. If a bear market occurs before you retire your portfolio won’t have enough time to recover before you need the money.
Younger people should also consider de-risking their portfolios if they have short term goals they want to use their investment money for. If you are 30, you don’t have to worry about your portfolio not having enough time to recover before retirement, so you can afford to be more aggressive with your retirement investments. But if you have your investment money earmarked for a downpayment on your first house within 1-2 years, you probably shouldn’t have that money invested in the stock market in the first place.
Another important point to consider is that you may have set your portfolio up in line with your goals a few years ago, but stocks have performed so well that it is now out of whack. You or your financial advisor should be rebalancing your portfolio about once a year -- if you aren’t, your current portfolio may be much riskier than you would like.
For example, if you created a portfolio that was 50% stocks and 50% bonds in 2010 -- but never rebalanced it -- as of September 2021 it would be 73% stocks and 27% stocks (link). Generally over time -- and as you get closer to retirement -- you want to invest less in stocks and more in bonds. However, because stocks tend to grow faster than bonds, unless you are actively rebalancing your portfolio your stock allocation will most likely grow rather than shrink over time. This results in a riskier portfolio than you are comfortable with, and it’s important to fix this before you get punished in a bear market.
Wondering if your portfolio matches your risk profile? You can take a free Riskalyze Risk analysis here which will help you understand your risk profile and how much risk you should be taking.
3) Spend from your winners
If you have to take any cash off the table, spend from your winners. At this point of a historic bull market you’re bound to have some winners. To profit from a market decline, you may want to take a look at those you may have held onto for a significant period of time and take some profits off of the table. When you are taking withdrawals, it will be important to have your core bond holdings secure in order to insulate your equities from sharp swings in the market. During equity declines, bonds tend to perform better as equities decline and investors rush to safety.
In Conclusion
Bear markets can be a scary time. The news outlets go crazy with draconian predictions, and your portfolio may take a hit. But if you have prepared the correct way a bear market is actually a great opportunity. Why? Because stocks go on sale!
If you have a long term investment horizon, and enough cash in your emergency fund, a bear market is the perfect time to get more aggressive. Stocks will be cheaper by 20% or more which means you can get more shares for less and hold them for the long term.
Wondering if your portfolio is ready for the next bear market? Schedule a free introductory meeting where we can talk about your portfolio and see if you are on track to meet your goals and aligned with your personal risk tolerance.
Source: Bloomberg L.P. Returns from 11/29/68–12/31/20. The S&P 500 Index is an unmanaged index of 500 stocks used to measure large-cap US stock market performance. Investors cannot invest directly in an index. Index returns do not reflect any fees, expenses, or sales charges. This chart is for illustrative purposes only and not indicative of any actual investment. These returns were the result of certain market factors and events which may not be repeated in the future. Past performance is no guarantee of future results.
Source: Invesco, Charles Schwab, Hartford Funds
Hardy Capital Investments is a registered investment advisor. Information provided on these sites is for informational and/or educational purposes only and is not, in any way, to be considered investment advice nor a recommendation of any investment product. Advice may only be provided by Hardy Capital Investments's advisory persons after entering into an advisory agreement and providing Hardy Capital Investments with all requested background and account information.
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