Investing in a Bear Market - 3 Steps To Taming The Bear
What You Need To Know
Most investor losses happen during bear markets with the average historical decline of bear markets being 36% and lasting on average 349 months.
The first step to bear market investing is admitting you are in a “Bear Market”.
In bear markets, there are only a few assets that have the potential for price appreciation creating opportunities for experienced, savvy, or tactical investors.
Successful bear market investing requires an investor to know their alternatives.
Bear Markets can be nerve-racking for many investors as they wonder how to invest their retirement savings and investments during times of broad market declines. For Red Zone investors (needing the use of funds in the next 5-7 years), bear markets can be outright emotional and scary. Just ask anyone that retired in the time frame of 1998-2003 or 2006-2010 and I assure you will hear stories of grave concern about the dreaded “outliving my assets” fear.
And, when you factor in the following statistics about retirement and bear markets, it becomes obvious to even crayon eaters that Baby Boomers and Gen X’ers need to know how to invest in bear markets just as much, if not more than knowing how to invest in bull markets.
According to Investopedia, research from the Insured Retirement Institute (IRI) shows that 45% of Baby Boomers have no retirement savings and out of the 55% who do, 28% have less than $100,000. Assuming a majority of that savings is in 401(k) or retirement accounts we can also assume there is a large chunk of that money allocated or invested in stocks and bonds which are the two asset classes bear markets have a tendency to affect the most. Having access to alternatives outside these two asset classes is paramount to investing successfully during bear markets.
Luckily, bear markets don't happen that often and they tend to be short-lived relative to bull markets. However, if one were to occur when you are in a Red Zone (think nearing retirement or recently retired) it can be quite detrimental when you consider, according to Invesco, the average bull market lasts 349 days and the average decline in bear markets tend to be around 36%. If you have a 3 to 7-year time horizon, 349 days and 36% is a big chunk of that time span.
In the event such declines happen to an individual person a year or two before or after they retire they may find themselves saying things like, “I moved back in with Mom because she needed my help” all the while Mom is still hittin the morning Zumba classes telling her friends “I'm not sure why my son/daughter thinks I need help or why he/she moving back in..." Sounds awkward, right?
Since we want all of you to live independently as long as possible, and nothing says “I'm having cash flow problems” more than moving back in with Mom, we have put together this quick three-step guide to investing in bear markets.
Step 1 - Admit You Are In A Bear Market
We imagine you’ve heard the humorous phrase “De-nial isn’t just a river in Egypt”?
Well, in bear markets, DENIAL is the flow of medium that leads to the emotion of panic. And, panic is what creates the potential for investors to experience drastic losses or drawdowns in their investment accounts. Especially if they were late to the investing party by putting money to work during a phase of market euphoria similar to what we have just experienced over the past year.
Long-time readers will be familiar with our denial panic continuum we share often as a way to exemplify how markets cycle from periods of euphoria to panic like a weekend trip with Johnny Depp and Amber Heard.
We bring this up because bear markets derive from complacency and carelessness, which is always a recipe for disaster. Complacency is the seed that sows denial and denial eventually leads to the panic emotions investors feel when they realize that denial has put them behind the curve of a market swoon. When investors realize they are behind the curve and feel the panic they start selling their investments indiscriminately in an act of capitulation to their emotions.
So, the first step to successful bear market investing is to recognize the signs of complacency and carelessness. If you are wondering what those signs are, just go back over the last year of our posts and past missives about euphoria in NFT’s, Crypto, SPACS, and the carelessness of our leaders focused on things like MMT to see a textbook example of how bull markets breed bear markets through complacency and carelessness.
After doing so, if you still find yourself saying things like “I’m just going to ride this out”, then you are still in denial and only the good lord can help you at that point.
Like a chip earning twelve stepper the first step is the hardest. After taking step one - admitting you are in a bear market - the next step is to overcome the “Diversification Dilemma”.
Step 2 - Overcome the “Diversification Dilemma”
Please don’t shoot the messenger but we need to announce that you have been lied to.
They’ve been lying about the merits of diversification and if you follow their guidance at the wrong time you will find yourself in a hell of a dilemma during a bear market.
Here is the bottom line, during a bear market almost all assets correlate and move in tandem in the same direction. Which usually is the wrong direction during bear markets.
In a bear market, it matters very little whether you have your investable assets diversified between the large-cap, small-cap, mid-cap, this sector, that sector, corporate bonds, or government bonds. When a bear market is accompanied by rising interest rates and rising inflation all those assets will have a tendency to get taken out to the woodshed and chopped up to some degree. While diversification may help mitigate potential declines relative to having your investments concentrated in one asset, it won't avoid declines and drawdowns during bear markets when assets correlate together to the downside. After all, when the tide goes out don't all boats go lower? It’s the same in bear markets. Nothing more, nothing less.
This leaves investors very few options or alternatives in how to solve this diversification dilemma which is both good and bad news. The bad news is, if you are not aware of, or don't have access to the few assets/alternatives that historically have had a chance of price appreciation during a bear market you may not be able to avoid the diversification dilemma. The good news is if you do have the knowledge and access to the alternatives that tend to perform better during bear markets the solution to the diversification dilemma is fairly easy as you only have to focus on the price action of 2 or 3 assets. Potentially making your portfolio diversification and management during bear markets much more streamlined, concise, and optimized.
Step 3 - Know Your Alternatives
As discussed, the good and bad news of bear markets is that very few alternatives exist for investors that are looking for ways to grow their net worth during bear markets. This is why they are called bear markets folks, most assets are in hibernation not out roaming the fields for opportunities.
The great news is, if you do have access to the few alternative investments that have historically performed better during bear markets you may be able to benefit from what every savvy investor eventually learns if they invest long enough. That bear markets are part of the territory and if you invest long enough you will have to eventually deal with a bear market. When that time comes you will most likely realize that drawdowns in account values happen in the course of investing and when they occur the best use of energy is to focus on how to recover as quickly as possible. Doing so requires knowing your alternatives because hedging a portfolio with these types of alternatives is how savvy investors assure themselves that they will have the dry powder and confidence to act when the right opportunities arise after a bear market passes.
While we don’t have the time or space to give you all the dark details on how to make a bear market your submissive using alternative investments, we can wrap up this missive by giving you a look over our shoulder at how we handle investing during bear markets and why we believe it is a better alternative to Wall Street’s traditional approach to diversification when you find yourself investing during a Red Zone of life.
In closing, what we are going to share with you are the four (4) investing hacks that have helped us optimize portfolio allocations during past bear markets. Keep in mind these are distilled insights we have gathered after observing how markets behave through a lens of time that covers bull and bear markets including the 1998 Russia default crisis through the 2000 Dot Com boom and bust to the 2008 Great Recession and beyond. Yes, we are getting so old that we can remember all of those events.
Depending upon the time frame of an investor's goals these fluctuations over the short-to-intermediate term time frame in the U.S. Dollar can have drastic effects on whether that investor reaches those goals or comes up shy of those goals. This is most relevant for investors that may find themselves within a “Red Zone” of life where they may need a significant portion of their invested dollars for a life change like retirement or a change in health within the next 5-7 years. For these investors, understanding how to optimize their investment portfolio with Dollar strength and weakness as a major consideration is just as pertinent if not more pertinent to achieving financial goals than having just a “diversified portfolio”.
Four (4) Bear Market Investing Hacks
While Wall Street has everyone focused on diversification, the real money is made by realizing our net worths are mainly influenced by five (5) asset classes and/or marketplaces. We like to call these the “Macro” or big picture items. They include real estate, equities, commodities, currencies, and interest rates (fixed income).
Each of these macro items has an interconnected relationship with another macro item. For example, the strength and weakness of The US Dollar can affect the price action in stocks and commodities just like the rise and fall in interest rates can affect the price action in real estate or fixed-income investments. Understanding which is the dog and which is the tail is the trick to this process.
Focus on correlation, not just diversification when building a portfolio's allocation. Understanding how many assets within your portfolio are correlated to the changes within these macro items is a powerful tool for managing risk and finding opportunities. For example, you could be diversified into ten (10) different fixed income mutual funds but if they all lose value when interest rates rise then all you have done is diversified yourself between ten (10) losing investments. In this example wouldn’t it be better to first identify the macro direction of interest rates and then based on that assumption determine which assets to allocate into that portion of your portfolio?
When investing, thoughtfulness can pay dividends. For us, thoughtfulness is displayed by using both technical and fundamental analysis to seek out opportunities while also managing risk. We could write textbooks and lull you to sleep with conversations about how technical analysis can be used to help investors identify when and where to buy, sell or hold while using fundamental analysis to identify the beginning and ending of secular trends. The best way to gain a better understanding of hack #4 is to follow our monthly publication “Market Minutes From The Boardroom”where we discuss the fundamental and technical landscapes of equities, interest rates, commodities, and real estate.
As you may begin to see, these four bear market investing hacks along with the three steps to bear market investing add a layer of strategy and tactics to a portfolio that is built on the fundamental structure of how capital flows in and out of financial markets and they add thoughtfulness and an intention of optimization to the idea behind diversification, not just a pretty pie chart.
Curious to know which alternative investments have historically performed best during bear markets?