A friend who is a bit younger than me told me that his financial advisor recommended selling his stocks in favor of bond funds because of the coming bear market. He asked me what I thought.
“That’s the dumbest thing I’ve ever heard, and you should fire them,” I said emphatically.
My friend was caught off-guard. “Why?” he asked.
“How do they know there’s going to be a bear market?” I retorted.
I elaborated that even the smartest and most successful economists, bankers, investors, and traders in the world can’t time the market. But this guy who cold calls people for a bank in Akron knows there’s going to be a bear market?
Then I asked my friend the most important question all investors should be asking themselves.
“How would a bear market affect you?”
Since 1900, the U.S. stock market has returned an average of 9.7% per year. That includes corrections, run-of-the-mill bear markets, and market crashes like the Great Depression, the dot-com crash, and the global financial crisis.
In order to capture that nearly double-digit annual gain, it’s important to stay in the market.
However, if you’ll need the money soon, that’s a different story.
I always recommend that any money you’ll need within three years not be invested in the market. That’s not because I think there’s a bear market coming – I make the same suggestion in the middle of raging bull markets. It’s because you never know what’s going to happen, and if you need cash in the short to intermediate term to pay bills, it shouldn’t be exposed to that much risk.
My friend is in his 40s, so he’s presumably 20 years from retirement. If the market crashed and stayed down for the next three years, he might not feel great when he checked his account statements, but it would have no effect on his ability to pay his mortgage or put food on the table.
Sure, it’s not fun to see your net worth go down. When that happens, people feel pessimistic and they may cut back their spending. But if the decline won’t impact your ability to do the things you need and want to do, making any moves simply because the market is falling is a terrible mistake.
You’ll never – and I mean NEVER – get back in near the bottom. That’s when things feel the worst. Don’t kid yourself by saying you’ll get out now and get back in when the market is lower. You won’t.
The only way you’ll buy near the bottom is if you have a system in place and stick to it. For example, you might invest every month or every quarter regardless of how the market’s looking.
If you sell because you’re worried about stocks going down, you’ll certainly miss the next move up – and probably for a while, because you’ll be gun-shy about getting back in. That’s just human nature.
If a bear market would not affect your ability to live the life you want within the next few years, ignore the news – including what’s going on in the market – and don’t do anything (other than perhaps putting more money to work).
If, on the other hand, a down market would negatively affect your lifestyle, then whatever amount of money you’ll need to live your life on your terms should be in safer investments, such as cash or individual bonds (not bond funds). These will help you generate income and ensure you get your capital back no matter what’s happening in the markets.
Answering the question “How would a bear market affect me?” and taking the appropriate action – even if it’s doing nothing – should alleviate a lot of the stress associated with falling markets.