How to Survive a Bear Attack: 6 Strategies for Embracing a Stock Market Downturn
How to Survive a Bear Attack
6 Strategies for Embracing a Stock Market Downturn
By: Stacey Nickens
I love heading out to nature for a hike or a camping trip, but enjoying nature doesn’t come without risks. You may face dehydration, mosquito bites, and even bears. A bear attack is certainly the worst case scenario, but preparing for the worst case scenario can help ensure you make the best decisions for your safety and your future.
Investing in the stock market comes with similar risks, and the way investors behave during a bear market can determine their long-term success. A 20% drop in market prices signals a bear market, but even during smaller market dips, the following seven strategies can help your portfolio survive and thrive when faced with a growling grizzly.
Play Dead
When faced with a bear, campers are advised to stay still and play dead. Doing so keeps the bear calm and helps you stay alive. The same advice is applicable in a bear market. Hold still. Don’t make any sudden movements. Take a few deep breaths. Such caution could protect you from selling your investments at the worst possible moment and missing out on the market recovery.
Keep Your Fears in Check
To survive a bear encounter, you need to remain calm enough to stay still. Similarly, during a market downturn, it can be prudent to spend extra time managing your emotions and coping with your fear. A study found that an average investor misses out on 6% of market returns each year due to emotional behavior during bear markets. Why is this the case? Bear markets and pullbacks are relatively common, and often times, equities experience the most growth after a significant drop. Accordingly, when investors pull out during bear markets, they risk selling investments at a loss while also missing out on potential gains during a market rebound.
The long-term cost of such behavior is staggering. Fidelity found that an investor who missed out on the five best market days between 1980 and 2018 would see their returns shrink by 35%. If the same investor missed out on the fifty best days during that timeframe, their returns would shrink by 91%.
With all of that said, one way to manage market fears is to normalize market downturns in your brain. From 1980 to 2018, U.S. stock markets saw 37 corrections, during which the S&P 500 fell an average of 15.6%. Even with these corrections, the S&P 500 has an average annual return of 10%. So when you see a headline saying that a market correction is on the horizon, you can remind yourself, “So what? Market corrections happen, and equities still tend to rebound and grow.”
Review Your Plan
Many bear encounters can be avoided with the correct planning. While planning can’t protect you from a market correction, a financial plan can help mitigate the impact of a market correction. A risk tolerance assessment should be part of your financial plan. Knowing how much volatility you can tolerate can help you avoid emotional behavior during bear markets. How much drawback could you experience before you would pull your money from the market? Talk to your advisor about your comfort levels with volatility, such that they can ensure your investments align with your ability to withstand risk.
When it comes to risk, you should consider what you would do if positions in your portfolio fell by 50%. Would you want to reallocate your portfolio? Would you want to sell off or buy certain positions? Would your financial health be impacted in the short-term?
Your answers to these questions can help you determine how much risk you’re willing to take and how much risk you can afford to take.
Expect Emergencies
Those who camp in bear territory need to plan accordingly. You keep your food locked away. You may know the location of the closest park ranger station.
You should also plan for financial emergencies. If a stock market correction would impact your short-term, financial well-being, you may need to build out a more robust emergency fund. Money that you will need in the next five years should likely not be invested in stocks. On average, it takes a portfolio a little over 4 years to recover from a 20% or greater market drawback. Accordingly, keep your short-term funds out of the market, such that your invested funds always have time to recover from market dips. You should also keep 3-6 months worth of living expenses in cash so you don’t need to sell equities to cover emergencies.
Additionally, consider if you will need funds to buy a house or pay for college in the short-term. Make sure to set aside cash for these larger expenses when the market is doing well. You can accordingly pay for planned expenses without having to sell investments at a loss during a market correction.
Similarly, you want to make sure you have investment funds available for market corrections. These funds will be used to buy healthy equities when their prices have dropped. Because you don’t want to sell during a correction, make sure to raise this cash-for-investing in advance.
Similarly, you can offset volatility stress by seeing market corrections as an opportunity. Think of market corrections as a sale at your favorite store. Before the sale, you could make a wishlist of stocks that you would buy should they become less expensive. With each 5% drop in the S&P 500, you can then see if your wishlist stocks have become more affordable. Seeing corrections as a “sale” opportunity to buy discounted equities may help you view bear markets with a more positive, normalized mindset.
Explore
The possibility that you will encounter a bear shouldn’t stop you from ever camping. Similarly, the potential for market downturns shouldn’t stop you from ever investing. Instead, you can use a strategy called Dollar Cost Averaging to reduce the impact of market timing and investor behavior on your portfolio’s returns. Instead of trying to time the market, an investor would calculate how much they want to invest over a period of time. For example, pretend Bill wants to invest $12,000 in his brokerage account during 2022. The investor then divides this lump sump ($12,000) by the time frame (12 months) to determine how much to invest at regular intervals. Bill could then decide to invest $1,000 on the first of each month.
Dollar Cost Averaging ensures investors are regularly contributing to their investment accounts and investing in a variety of market conditions. Doing so could help investors avoid making counterproductive decisions based out of fear or pride.
Diversify
Just as you can physically prepare for some of the challenges nature may throw your way, you can physically prepare your portfolio for challenging moments. Diversifying your investments doesn’t prevent downturns from impacting your portfolio, but a well-diversified portfolio has a better chance of withstanding market downturns and recovering more quickly.
