Lifeboat Lessons
How to prepare for, live through, and come to love Bear Markets!
The close of 2024 is fast approaching, and what a great year it’s been for equity values! Major market indices are up over 25% as of this writing, which is well above the long-term 10% average annual growth.
With that good news in mind, we thought it appropriate to discuss how we manage the opposite of today’s heady good times – otherwise known as a Bear Market. Just as with lifeboat drills, it’s best to review the specifics while the seas are calm and the skies are sunny.
A Bear Market is a dramatic, unexpected, and often terrifying decline in equity asset values of 20% or more, typically occurring every 5 years or so. We can look at the history of bear markets to gain perspective (thanks to our friends at First Trust). The typical bear market consists of a 31.7 % decline in values occurring over an average of 11.1 months. Accompanying every decline is a story claiming that “this time is different,” and that the economy and the great companies of American and the World are at risk of permanent damage. Inevitably this story turns out to be false and markets recover with a multi-year rise that eventually erases any memory of the event.
At Optimist, we have navigated the five most recent Bear Markets as advisors, and we have learned that these terrifying Bear Markets are, in fact, rare and precious opportunities of historic magnitude. From our vantage point, every five years or so, the great companies of America and the World go on sale! Please look again at the history of bear markets with fresh eyes.
For you to gain the correct mindset to capitalize on this opportunity, a deeper understanding of risk is necessary. Properly understood, risk is simply describing temporary negative volatility. Remember, permanent upward volatility is why we are investing in the first place—don’t become distracted by passing upheavals and waves! It is only when investors act rashly to avoid this temporary downward volatility that they run into problems because they inadvertently avoid both the temporary downs and the permanent ups of the market.
Consequently, for those not yet retired, the best approach to Bear Markets is to ride them out. Markets will decline sometime after achieving the next 100% return and it’s impossible to know when. Since the market cannot be predicted or timed, why try?
Conversely, if you are retired and taking income, now is a good time to refresh your cash reserves while asset prices are at historic highs. How much reserve is enough will depend on your withdrawals after accounting for third-party income and dividends. Additionally, checking the levels of your deep reserve assets, such as Fixed Index Annuities or Buffered ETFs, is advisable. If you need help in understanding the best plan for your circumstances, let us schedule a call, ZOOM or in-person meeting to discuss. In either case, in the aftermath of a major decline, all investors should adopt an optimistic outlook. Market turbulence is entirely normal and expected. All we can do is remain stoic and anticipate the opportunity that always follows. It is essential to recalibrate your portfolio when the market is completely “de-risked” due to the latest Bear Market—which includes rebalancing to higher-value assets and increasing exposure with specific investments. Please remember we’ll be right by your side when the next Bear Market hits, handing you a life vest and reviewing the steps of our lifeboat drill, while always encouraging you to look on the bright side!