investing

5 Things to Do in a Bear Market

No one knows when we're headed for an official bear market (you can only learn that in hindsight, unfortunately), so here's what investors should do today, no matter what's happening on Wall Street.

Bear markets, technically, are a 20% drop in the stock market, but who wants to wait that long to find out it’s a bear?

Bear markets, corrections and volatility all look pretty much the same at the beginning. When the market is down 5%, how do you know if it is going to be a correction (10% decline) or a bear (20% or more decline)? You don’t.

And here’s another little secret: They don’t ring a bell at the top of the market. The major tops over the past few decades all had the same thing in common, which is there was no clear catalyst for the decline. Today, investors and pros alike are looking for the catalyst, the bell at the top if you will. But history shows there was no catalyst for the 2008 crash, no catalyst for the Tech Wreck and no catalyst for the Crash in 1987.

The one thing the 2008 crash and the Tech Wreck had in common was that the market was very overvalued. As is today’s market.

Bears don’t happen when the market is cheap. They happen when the market is expensive, overvalued. Maybe the market will find some support and rally. Maybe the market will continue its decline until the valuation of the market becomes reasonable again, even cheap.

Investors’ emotions are their biggest enemy in a bear market. They can cause you to do and think irrational things. They can cause you to sell out of good companies. Bear market rallies can get you excited that the bear is over, and then you might be buying too soon. Emotions are the enemy, not the bear.

But in the meantime, there are a number of things investors should do:

1. Review your portfolio with your adviser.

Don’t be afraid to take some profits. Unload any holdings that you are not comfortable with. Don’t be afraid to hold onto good, quality stocks as they go through the bear. Your broker certainly doesn’t know when the market will bottom, so why get rid of some quality companies? A falling stock price does not mean that the company is going out of business. There are plenty of big blue-chip stocks that have gone through previous bears and came out the other side.

2. Have realistic expectations.

If the market is down 10%, expect to be down 10% if you have a portfolio of stocks. Expect to be down more than 10% if you have aggressive holdings. If you are down only 5%, great! Be happy. While no one wants to lose money, to lose less than the market when it is going through a correction is a good thing. It means your asset allocation and/or investment selection is protecting your portfolio. (BTW – Why do they call it a correction? Because the prices of overpriced stocks are being “corrected” down to where they are better priced.)

3. Do not extrapolate.

A market down 15% does not translate into you losing all of your money. Don’t call your broker in a panic, afraid you have lost all your money. A market down 20% in a month doesn’t mean that in four more months you will have lost everything. Markets go up and markets go down. Investors tend to think that whatever the current environment is will go on forever (or at least for the foreseeable future). Bull markets will never have a top, and bear markets will never come back up. Do yourself and your rep a favor and do not think this way. It will only make you crazy. Bear markets follow bulls and bulls follow bears. It has always been that way and always will.

4. Do not expect to sell the top and buy the bottom.

This is just not possible. For one thing, the tops and bottoms are only clear in hindsight. Professional money managers have a variety of tools they use to determine when to buy and sell, and I can assure you, no one has a tool that tells them where the tops and bottoms are.

What you want is for your money manager to maintain his strategy. A more tactical strategy may involve active selling and buying. Maybe he will sell somethings near tops, but it isn’t by design. If the strategy is to buy quality and hold on, do not expect him to sell just because the price is down.

5. Determine your risk tolerance.

If you have not quantified your risk tolerance, now is a good time. Make sure your portfolio matches your risk tolerance. (Labeling yourself conservative, moderate and aggressive is no longer enough. The risk needs to be quantified with real data.) A good risk analysis will quantify your risk tolerance through a questionnaire that will give real-life examples of potential upside and downside. There are no right or wrong answers. It measures your own tolerance of risk. Usually, the results are a Risk Score. The next step is to evaluate your current portfolio’s risk. This is normally done with historical data, and it results in a Portfolio Risk Score. Ideally, you want the two scores to match. If not, adjust the portfolio until they do. Be realistic with your risk tolerance. Sometimes investors will score very high on risk tolerance, but then panic at the slightest decline.

Bonus – Have patience. Bear markets feel like they are going to last forever, but they don’t. If you stay with good, quality investments, you should make it through all right. That doesn’t mean your investments won’t go down in value during a bear market, but there are numerous companies that have been around for decades that have seen several bear markets and have lived to grow bigger and stronger.

You may have to turn off the financial news for a while. On the one hand, there are commentators that are perma-bulls, and every day is a great day to invest. They are blind to the realities of a bear market and do not give investors good advice. On the other hand are the fear mongers. Every downtick in the market is bringing us closer to a complete collapse of the market, the economy, society and even the solar system! They live to scare. Bear markets are hard enough without hearing those doom and gloom prophesies!

It is best to make sure you keep a level head, keep the proper perspective and review your portfolio. If you like what you have, sit back and watch a movie, or go out with your family. Let somebody else get taken away by their emotions.

Third-party posts do not reflect the views of Cantella & Co Inc. or Cornerstone Investment Services, LLC. Any links to third-party sites are believed to be reliable but have not been independently reviewed by Cantella & Co. Inc. or Cornerstone Investment Services, LLC. Securities offered through Cantella & Co., Inc., Member FINRA/SIPC. Advisory Services offered through Cornerstone Investment Services, LLC's RIA.

About the Author

John Riley, AIF

Chief Strategist, Cornerstone Investment Services

In 1999, John Riley established Cornerstone Investment Services to offer investors an alternative to Wall Street. He is unique among financial advisers for having passed the Series 86 and 87 exams to become a registered Research Analyst. Since breaking free of the crowd, John has been able to manage clients' money in a way that prepares them for the trends he sees in the markets and the surprises Wall Street misses.

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