Well, here we are on the cusp of another bear market. If the S&P 500 falls a few more percentage points from the time of the writing of this column, we’ll be in our fourth bear market in 22 years. Bear markets are generally defined as declines of 20% or more.
We can debate until the cows come home why we are in this situation, what needs to be done to fix it, and when it will get corrected. But nobody knows how this process will proceed and what’s in store for markets as the Federal Reserve ramps up its inflation-fighting activity. Thus, investors find themselves wondering what they should do.
I know this advice sounds trite, but it’s the same advice you hear every time the stock market tanks. Basically, stay the course. The reason you hear it is because it has worked time and time again. Markets bend, but they have not broken. This advice is based on historical evidence, not just wishful thinking. And history is one of the main tools we have for assessing risks in markets. Every stock market decline has been followed by a recovery, and those who stayed the course were rewarded with more wealth. Those who left likely sold at lows and later bought back at much higher prices.
But I know what you’re thinking, “Yeah, historically it hasn’t broken, but there are no guarantees.” Yes, that’s correct — there are no guarantees. But if you want to invest in stocks, you have to accept this uncertainty. The uncertainty, however, changes with time. The more time that goes by, the higher the odds are that you’ll have gains. It’s important to look beyond the current challenges. Markets and investors are resilient. They figure things out, but it’s a process.
Right now, the U.S. economy is in a tough spot. Mistakes were made. Too much money was pumped into the economy to combat COVID-19, and now we have rampant inflation. That inflation needs to be brought under control. Inflation is a bigger threat to your long-term ability to accumulate wealth than a temporary bear market is. So, we should feel positive about the fact that the Federal Reserve is dealing with it. But it doesn’t make the process any more fun. Yet, we simply have to get through this.
Now, even though the standard advice is to stay fundamentally invested, there are some things you should do as we head into what could be another leg down for markets.
First, determine if your stock portfolio is fundamentally diversified. In general, that means owning a collection of companies that span multiple industries and sectors, such as industrials, technology, health care, financials, consumer staples, etc. You can easily diversify by using something like an S&P 500 index fund, a total stock market index fund, or any number of well-diversified mutual funds.
Diversification is important because when we talk about markets recovering, that statistic applies to diversified portfolios. If you only have a few stocks or are concentrated in a few sectors, your experience may not be reflective of an overall market recovery.
Second, review your portfolio to determine if you are holding investments that you don’t understand. If you don’t understand an investment, either talk to someone who can help you figure out what you own or consider moving on from that investment. Anecdotally, when I have encountered investors who have had unusually negative investment experiences, it’s usually because they didn’t understand what they owned.
When I use the term understand, I mean you should understand what the risk and return profile is for the investment. For instance, is it designed to track the broad stock market? Or, is it designed to only track a sector, like energy or technology, or a specific style of investing such as value or growth? It’s fine to hold any of these investments, but you should fundamentally understand what they are designed to do and whether they fit with the overall structure of your portfolio.
Third, if you need cash for expenses in the next four or five years, make sure you aren’t relying on stock market gains to provide that cash. Many bear markets are over in a few years, but some last longer. The 2008 stock market decline lasted roughly five years before it regained its previous high. To bridge these bear market gaps, consider holding some form of more stable assets that you can dip into if necessary. These would be things like cash, CDs, and U.S. Treasury bonds.
Fourth, work on your own spending and budget. This is a good time to tighten your belt and eliminate extraneous expenses that aren’t adding much value to your quality of life. Corporate America is already doing this. So, take a cue from them and start scouring your spending for things you can cut.
Staying fundamentally invested doesn’t mean “do nothing.” There are things you can do to prepare for what may be a tough cycle. It’s like when the captain of a ship says, “batten down the hatches.” The captain doesn’t plan on sinking, but they are getting prepared for a rough ride.
Charlie Farrell is a partner and managing director at Beacon Pointe Advisors LLC. The information contained in this article is for general informational purposes only. Opinions referenced are as of the publication date and may be modified because of changes in the market or economic conditions and may not necessarily come to pass. All investments involve risks, including the loss of principal.