How to deal with a Bear Market?

 We are far from simple volatility in the markets. With the possibility of a global economic recession, continued high oil prices, ongoing war in eastern Europe, leadership assassination (Japan), leadership resignations (UK), countries in default (Sri Lanka), and the usual list of vulnerable and unstable regions, it seems there is no place to hide this summer of 2022. Indices such as the S&P 500 and NASDAQ are off over 18% and 25% respectively this year, and many other markets are even worse off. Is this a market crash? Let’s see how to deal with a Bear Market.

A BEAR MARKET

What is a Bear Market? It is typically described – in an over-simplified way – as a condition in which securities prices (worldwide or in specific regions) fall 20% or more from recent highs. It can be caused by widespread pessimism and negative investor sentiment or by clear major macroeconomic trends (economic downturn, recession, political/social/economic crisis. etc). How long will it last this Bear Market? Like with every financial cycle, It is impossible to say. It could be 1 week, 1 month, or 10 years.  

Despite the daily drama and its financial and economic impact,  we still need to keep things in perspective. So far markets are still far from the historical lows of the financial crisis of 2008 or the covid crisis of 2020.

During any upcoming bear market, It is always helpful to look back in history, check the patterns, and collect enough datasets to know where we are in the market cycle (Howard Marks). While history does not (necessary) repeat itself, it often rhymes. We can just try to be prepared with an all-weather portfolio or adjust it along the course.    

I am sure you know it by now: markets are cyclical, bear markets come and go, and you can just embrace the cycle and make the best out of it. However, it’s easy to make emotional decisions that can derail your financial future.

As I like to say: Financial education plus discipline equals financial freedom. As such, the best course is to work on your mindset: breathe, maintain a rational approach and control your fears. Secondly, have a clear financial plan (financial education) and stick to it (discipline).

7 STEPS TO GO THROUGH DURING A BEAR MARKET

Here are a few steps you can take now to help you take an objective look at your portfolio, limit the damage, and help protect both your personal and financial well-being during any bear market.

1) First of all, don’t panic. The “losses” in your portfolio aren’t permanent unless you make them so. Fear-based selling just locks in losses, triggers taxable capital gains, and increases the chance you will miss the next up leg of the market. Giving in to short-term emotional decision-making is the reason most individual investors fail to achieve their investment goals. (check out my notes on Howard Marks memo: When to Buy or Sell securities)

2) Review your emergency funds. Ensure you have 3 to 6 months (depending on your family structure, age, and sources of income) of living expenses set aside in a cash account to fund unexpected events such as a job loss or illness. The funds should be liquid, risk-free, and in the currency, you will likely need them in. 

3) Review your short-term goal and its funding. Take a look at your financial goals over the next 3 to 5 years. Set aside funds for these goals in low-risk, liquid investments in the currency that will fund the goal. These funds do not belong in equity. In fact, it may make sense to hold these funds in an account separate from your long-term portfolio to help you manage the different asset allocations, time horizons, and risks associated with your various financial goals.

4) Make sure you are diversified. The point of diversification is to reduce the risk of catastrophic loss by not having all of your funds in one investment. It doesn’t mean you will never experience a market downturn or a loss. You should be in a broad range of both fixed income (bonds) and equity asset classes held in a mix that is appropriate for the amount of risk/volatility you can accept in your portfolio. The S&P 500 may be down 20% this year, but no properly diversified portfolio should even be down close to that in this period.

5) Reassess your risk tolerance. If you’ve ever worked with a financial advisor, private banker or even online robot advisers, you’ve no doubt filled out some version of a risk tolerance questionnaire. The point of the questionnaire is to help in the construction of a portfolio that matches your willingness and ability to bear risk in your investment portfolio.

It’s one thing to say you’re willing to bear a 20% markdown in your portfolio’s value during the space of a tough year in the pursuit of longer-term investment returns. It may be an entirely different thing when your portfolio is actually down 20%. This is a good time to get a read on your real risk tolerance. Determine the short-term loss you were able to bear before becoming extremely uncomfortable. That is likely a closer estimation of your risk tolerance than any questionnaire can provide.

If the current market downturn has already exceeded your comfort zone, you may need to redo your portfolio. It’s better to have a more conservative portfolio that you can stick with throughout the market’s ups and downs rather than a more aggressive portfolio you are forced to abandon when the going gets rough.

6) Be wary of “safe havens” like gold, bitcoin, or any asset that has become a home for investors fleeing risk. Investments like these rise not because of any intrinsic economic return afforded investors, such as that provided by stocks and bonds, but simply because more and more people are buying them. Increased fund flows to investments such as gold are driven by more and more investors fleeing risk (or speculating) rather than by any long-run economic return embedded in the asset.

The meteoric rise in the price of gold (gold is impossible to value, Damodaran), while other assets are falling, can give the illusion of security, but anything backed by little more than pyramid buying can collapse just as quickly. Investments like these can be a bit like a Ponzi scheme. You don’t want to be the one left holding the bag (Bitcoin and the greater fool theory, Warren Buffett).

7) Continue to rebalance or contribute to your portfolio. In times like these, it may be tempting to stop contributing to your portfolio or avoid rebalancing back into asset classes that have been going down in value. This is where the gains are made though. If you wait until everything looks back “to normal”, all you are doing is buying in at the peaks, which will significantly reduce your long-run portfolio return. You can’t time the market, but by consistently contributing to your portfolio (Dollar cost-averaging) and/or moving to your core investment weightings, you can ensure that you will put more money to work when prices are low. This will help set you up for better investment returns over the long run.

CONCLUSION

Recall the popular adage: we met the enemy. It is us. The investors who will come out ahead, in the long run, are the ones who can avoid being panicked into the self-destructive cycle of buying high and selling low, which naturally happens when we react to “news” by buying and selling out of fear of losses or fear of missing opportunities (FMO).

Do yourself a favour and turn off the so-called financial news (financial porn). Make sure you have a steady income (one or multiple income sources), that your short-term goals are funded appropriately and then focus on your daily life and healthy intentional lifestyle. Later, come back and take a calm, objective look at your portfolio.

Keep it real. Sweat Your Assets. 

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