The Four Bear Market Survival Tools

Investing, like everything in life, involves risk. Even in areas of our personal lives, we “invest” in things like relationships or causes, and those still have risk. The same is true for any investment of our hard-earned dollars: the promise of growth into the future also includes the risk of loss. Like it or not, risk is normal.  Risk is never completely avoidable.

So, if you are a life-long investor, you’ll eventually face bear markets.  What happens when the market corrects radically and suffers decline?  What are your next steps?

Thankfully, the effects of a severe market downturn can be anticipated and minimized.  You can survive a bear market by employing key strategies and avoiding the most common pitfalls. 

Let’s begin by defining what we mean by “bear market”.

What is a Bear Market?

A “bear market” is technically defined as that point at which stock prices have fallen 20% or more from their most recent high. A “market correction” is similar, although not as severe, and occurs when the market declines 10% from its most recent high.  The S&P 500 and other indexes are key indicators of prices, and these indexes are often the measuring gauge for announcing the arrival of a “bear market”. Once an index falls below 20% of its recent high, the markets have entered bear market territory.

As seen during the recent Great Recession (2008-9), or other major economic events (like the decline from the pandemic in early 2020), these bear markets can be very severe, and may occur quickly without warning.  On average, bear markets experience a decline in stock prices of 32% on average. However, the following tools can be useful to help you reduce the impact of a bear market, and, in turn, protect your attainment of long-run goals for your portfolio.

1. Maintain the Proper Balance

One of the greatest tools at your disposal to protect your investments is proper portfolio composition. Specifically, a diversified portfolio that fits your risk profile as an investor is ideal. What does this mean? Your mix of stocks (large-cap, small-cap, etc.) and bonds (global, domestic, corporate, or government) can greatly determine how a bear market affects your portfolio value.  This can mitigate the impact of the decline in the short term, and perhaps more important, assure the full recovery and advance in the long term.

When markets get volatile, reactive investors tend to flock to cash and bonds as a safe haven, where the added demand for safety drives up the price of bond investments. Conversely, when investors are feeling the worst may be over and therefore more confident about markets, they jump into stocks, and prices rise.

Why a Balanced Portfolio May Protect Your Investments

Maintaining some version of a balanced portfolio can help to protect your investments during a market downturn. If stock investments make up the vast majority of your portfolio (aggressive), you are assuming a higher degree of risk. During the Great Recession alone, U.S. large-cap stocks fell almost 60% from their previous high, crushing many investors who were heavily invested in certain stocks.

During our 50+ years of helping clients, we have had many chances to observe the emotional response of human beings scrutinizing these declines in stock prices.  In the recent pandemic decline of 2020 (which was average in degree, but which occurred with the fastest speed on record), we had to remind a number of clients not to “jump off the ledge” in fear and sell all their stocks after a fast decline.  Because they had at least some of their portfolio allocated to bonds and cash (which had not declined), they had resources available for their needs that did not require selling at a loss.  That provided “staying power”.

However, owning only bond and cash investments is almost always too conservative, preventing you from experiencing growth during a bull market. Often, market declines occur to the surprise of many investors and can be very difficult to spot, so it’s best to proactively protect a reasonable portion of your investments, rather than being forced to react to the panic from a bear market.

Working with your financial advisor to find the right blend of stocks and bonds in a balanced portfolio is your best strategy. It can give you the opportunity to grow when markets rise, and survive a bear market, or even stay reasonably protected as a downturn runs its course.

So, what do you do if a diversified portfolio falls in value?

Are your investments prepared for a potential bear market? Reach out to one of our advisors today to be sure.

2. turn “Lemons” into “Lemonade"

Since markets almost invariably fall at the onset or during an economic recession, it’s perfectly normal to experience declines in the prices of your stock investments, which normally prove to be temporary. The good news is, even those temporary losses can be advantageous if used properly. 

As a reminder, an investment “loss” is only locked in and realized when it's sold. If you continue to own it, you are still able to receive dividends, and there’s always the chance (or even likelihood) that the investment’s price will rebound. But, if you feel you have an investment that is truly underperforming, and you decide to sell it, do so strategically and use the opportunity to improve your portfolio’s posture for the future.

Potentially Reduce Your Capital Gains Taxes

Remember, when you sell an investment at a profit in a non-retirement account, you are liable for taxes on the capital gain. Remember, however, that these capital gains (and their taxes) can be offset by your capital losses which can reduce your tax burden during the year you sell your investments which have declined in price.  And if realized capital losses are greater than gains which are taxable, the excess capital losses can be carried forward and used up in future tax years to offset later gains, and even to reduce your regular taxable income.

Do you have a stock, mutual fund, or other investment that has performed well and realized a taxable gain? Great! Selling another investment that is down in price can lower your tax bill if you have capital gains.

If you do choose to make sales of investments that have declined in price, it is permissible to buy them back for potential recovery, but be careful to avoid the so-called “wash sale” rules.  Generally, you must wait at least 31 days to reinvest in the same investment if you desire to be able to count the loss on your tax return.

Losses, though disappointing, can still be used to your advantage.

3. Avoid Reaction and Market Timing

As we all know, hindsight is 20/20. Many look at the Great Recession, the recession of the 1980s, or any other economic crisis and claim that experts could’ve easily spotted the downturns in advance. Some “experts” might have done so; but usually this is a case of being “lucky, not smart”.  The fact is -- it’s extremely difficult to time the markets, and the record is quite clear that the probabilities are against you doing so successfully.

First, knowing when to sell ahead of a bear market is difficult.  At the top of the market, everyone is feeling good and optimistic.  There is not a natural urge to exit.  Moreover, after a bear market has begun, attempting to spot the bottom, and knowing when it is time to start buying again in the midst of a bear market, is an extremely difficult task. The emotion of being able to buy stocks when it feels like the “blood is in the streets” is immensely challenging.

History has proven that it is a far better strategy to stick with your well-conceived (and hopefully tested) prescribed portfolio strategy to simply ride out the volatility. Also, if your personal finances are healthy, you can also continue your scheduled investment plan. Keep putting money into your 401(k), 403(b), IRA, or any other investment account during a downturn.  This is exactly what make dollar-cost-averaging so effective. 

You’ll be able to capture investments at potentially lower prices, without worrying about timing the market during a correction or bear market. Historically, every bear market has come to an end and been followed by recovery and further growth.

4. Understand Bear Markets Aren’t Permanent

On average, bear market periods last less than a year. Some declines are slower and more protracted, which is typically more emotionally challenging.  We certainly saw this with our clients during the market decline in the Great Recession (which unfolded from high to low over a period of 30 months).  These periods of investment uncertainty can be agonizing, and the recovery periods can take a while as well. In the event that another bear market takes place, try to remember that these periods of time are characterized by sensationalism and panic in the news and financial press, but – on average at least -- they are shorter than 12 months. 

On top of that, bear markets tend to be coupled with economic crises or recessions, so investors are technically waiting for 2 separate recoveries. These recoveries can have strong gains, albeit volatile and met with skepticism.  Market decline usually precedes economic decline, and market recovery almost always begins before the turn up in the economy.

The Bottom Line

To survive a bear market and come out stronger, start now by meeting with an advisor to put together an appropriately balanced, diversified portfolio and a sound financial game plan. You’ll be prepared for a market downturn and have the right portfolio to cushion the blow of market declines.

If you have any profitable investments, see if you have any similarly held investments that you are comfortable selling to reduce your tax burden. 

Since bear markets are mostly short to medium-term, following these strategies can help you keep your portfolio and investments intact, and fully participate in potential market gains when the bear market period ends.

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William "Bill" Kring, CFP®

As a member of our Atlanta Wealth & Pension team, William "Bill" Kring is a Managing Director and Wealth Advisor for Linscomb & Williams.

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