In March 2020, the U.S. stock market entered a bear market for the first time since the Great Recession, ending a record bull market run. For many investors, the drop in stock prices was the largest decline they’ve ever witnessed. And many of them didn’t know how to invest in a bear market.
For others, the timing couldn’t possibly be worse. This was particularly true for recent retirees who expected their nest egg to generate income.
But for long-term investors, with cash sitting on the sideline and long investment horizons, this decline in market conditions represented an opportunity to take advantage of a short drop in share prices. And they were rewarded when these sharp declines quickly reversed themselves.
I was an investment advisor during this time. When stocks started tumbling because of unprecedented, worldwide concerns over the coronavirus, our firm started reaching out to our clients for two reasons.
First, many of our clients had never been with us during a market downturn, and we wanted to give them assurance.
Second, we wanted to see what questions people had about their portfolios.
While each client conversation was unique, we noticed that most of our clients had similar questions. So we started keeping track of them.
Below is a list of the 5 most common client questions I received as an investment adviser.
Bear Market Question #1: Will my portfolio be okay?
This was probably the most common question that was on our clients’ minds, even if they didn’t ask it. If this question comes to mind for you, you have every right to expect your financial advisor to talk you through it.
A low-fee, properly diversified investment portfolio is no guarantee against stock market downturns. However, such a portfolio (consisting of stock index funds) most likely will rebound faster and perform better than a high-risk, high-cost investment that got ‘sold’ to you in a good market.
If you do not have an advisor, you may want to take a look at your current investment strategy. Or ask a fee-only advisor for their honest opinion.
While specific investment advice is beyond the scope of this column, below are some ways to see how well your portfolio might hold up in a market downturn.
Are you paying too much in fees?
Are you paying more than 1% on mutual funds or exchange traded funds (ETF)? If so, can you say with certainty that the mutual fund is doing ‘better’ than the others?
Probably not. And paying above-market costs when the financial markets are in bear market territory just adds insult to injury.
Do you understand the purpose of each of your holdings?
Each investment should have a specific, long term purpose in your portfolio. If your advisor recommended an investment, they should be able to answer any question you have about why that investment is in your portfolio.
And the proper answer is that your advisor believes there is a very clear, specific role for that holding in helping to diversify your portfolio.
Is your portfolio properly diversified?
This might be the hardest question for you to independently answer. But if you’re working with a financial advisor, you should be able to ask this question.
Your advisor should walk you through your holdings on a regular basis. Not just after a steep drop in your investment portfolio.
Is your portfolio right for your situation?
This is another difficult question. The answer depends just as much on your life situation as it does on your actual holdings.
Someone who just retired is going to expect a different asset allocation from someone who is in their 30s. The latter probably expects to work for another 20-30 years, and is willing to put away huge chunks of money when stocks ‘go on sale.’ While the recent retiree needs to generate income to support their living expenses.
But odds are, you probably will have a feeling about whether your portfolio is right. If that feeling is not a good one, trust your gut and start asking your advisor.
Again, the right answer to these four questions is no guarantee. However, if you feel like something’s not right, then you should start asking deeper questions.
Bear Market Question #2: What if I need money?
There are two versions of this question. First, you might need money for things that had nothing to do with the stock market. This could be for living expenses, a special purchase, or an emergent need.
Second, you might feel a little more secure. Perhaps you want additional cash while the stock market ‘plays itself out.’
Let’s handle each question separately.
1. You need money for already anticipated reasons.
Your needs might not have changed. But it’s important to realize that market declines might not be the best time to sell investments. In fact, selling during a significant decline can do long-term damage to your investment returns.
It might be worth looking into a couple of things:
- Can you wait until the stock market recovers?
- If you sell, do you have capital gains?
- Are you able to get the money from elsewhere?
- Would you be able to generate this cash as part of rebalancing your portfolio?
These are all questions you might ask your investment advisor. Yes, even the tax question. If your advisor can’t help you talk about the tax implications, you should fire your advisor and hire a new one.
2. I need more security.
This is a pretty common statement. But it’s such a vague question, that it’s hard to answer. Perhaps there’s a preconceived answer, such as “I’ll only feel safe when all my investments are in cash.”
There are ways to provide security. You can invest in safe-haven assets, like a bond or CD ladder, without having to sell out of investments.
Ask your financial advisor on the best way they can help provide stability to your portfolio.
During this downturn, all of our clients stayed put in their investment portfolios. Most of them personally had strong balance sheets and could wait it out.
We had one client who wanted us to sell everything! Since we couldn’t convince her to wait, we did what we were ordered to do. And it was one of the worst investment decisions I’ve personally witnessed.
In fact, it was the worst-case scenario. The day we sold, the markets stopped trading. When they reopened, there was a huge drop in equity securities across the board.
Not only did she lock in her losses, but she incurred HUGE capital gains on top of them. But in her mind, it was the best thing she could have done.
Bear Market Question #3: When should I sell?
Investor fear is one of the big motivators behind selling.
This question gets asked primarily by investors with large individual stock holdings. During a falling market, those investors become obsessed with the daily stock price movement of a particular company. And when that stock’s price comes down from recent highs, those investors get antsy.
Inevitably, a worried investor sells part or all of a valuable asset based on market sentiment. And when market prices recover, the investor realizes they sold at the beginning of a new bull market. Instead of waiting for good stocks to return to an all time high, the investor loses out. For no good reason.
So when should you sell?
When I was an investment adviser, there are lots of variables that we would consider when selling securities.
There are taxes and fees, as previously mentioned. We might recommend selling out of a mutual fund where the leadership has recently changed. We might recommend selling out of an ETF that has recently raised its fees, or into one that has recently lowered its fees yet still does the same job.
But we would recommend selling for any (or all) of these reasons as a part of our normal rebalancing process.
We would not have recommended selling investments just because the stock market dropped 30%. Would you sell your house when you looked on Zillow and found out that the recommended price is only 70% of its previous value?
In fact, for clients in the right position, we might recommend this as a buying opportunity.
Bear Market Question #4: When should I buy?
Do we buy everything right now? Maybe. Maybe not.
When there’s a steady decline in the market, you don’t know if it’s a buying opportunity or if there’s another 10% to go.
But a common approach, and one that has worked often for patient investors, is called dollar-cost averaging. Dollar-cost averaging is one of the most useful tools for a long-term investor to consider.
The concept is pretty simple. Take the amount of money you have to invest, and spread out your investments over a matter of weeks or months.
The reason you would do this is to take advantage of buying more shares of investments when prices are lower. In a declining market, dollar-cost averaging will lead to a lower average price on your investment.
A dollar cost averaging scenario might look like this:
Company X is currently selling for $48 per share, down 25% from its high of $64.
We have $12,000 to invest. Instead of investing all at once, a dollar-cost averaging approach could look like one of the following:
- Option A: $2,000 on the 1st of each month over the next 6 months
- Option B: $4,000 on the 15th of each month over the next 3 months
- Option C: $1,000 on the 1st and 15th of each month over the next 6 months
There are literally an infinite number of dollar-cost averaging scenarios.
But what’s important is that the dollar cost averaging approach does not depend on the stock price itself, but rather on the same date each month.
That way, the money is being invested systematically. We might get lucky and pick up some shares for $45, or we might buy fewer shares at $50.
We’re not looking for the best price. We’re spreading out our investment so that we buy more shares when the investment is cheap, and fewer shares when it’s more expensive. That’s a strategy that pays off in the long run.
But what about the short term market trends?
Bear Market Question #5: What if this lasts longer than everyone thought?
This depends on the rest of your financial picture.
If you depend on your portfolio to generate income for you:
If you’re retired, you might want to sit down with your advisor. to learn how an extended bear market might impact your long term goals.
When I was an advisor, our goal for retired clients is to have 10 years of living expenses captured in their bond ladder. The bond ladder was the part of our clients’ portfolio that they could draw their living expenses from. And the good news is that a bear market has never lasted more than 10 years.
We would hold these bonds and CDs to maturity. That way we could reasonably predict when that money will be available to them, based on the prevailing interest rates.
That way, the rest of the client’s portfolio could weather the storm without a significant impact to their daily lives.
Even if your bond ladder is only 5-6 years, that will likely be enough to get through most downward trends or an economic recession.
If you don’t depend on your portfolio to generate income:
If you’re in your prime earning years, you might have the ability to invest in your retirement accounts or investment accounts.
You might also consider Roth conversions during a down market. Doing this will help you get more ‘bang for the buck’ in moving investments during the down market cycles.
Of course, you’ll want to still do proper financial planning to ensure you’re well-positioned in the case of:
- Layoffs, which are common during an economic recession
- Decline in the real estate market
- Sudden impact events, like a hospitalization or other traumatic event
Regardless of where you are in life, you should be able to communicate with your financial advisor to better understand your investment portfolio. And your advisor should be expecting your calls so they can walk you through how to invest in a bear market.
That is, if they’re not calling or otherwise reaching out to you. You’re the client, and this is the exact time where financial advisors earn their money—when times are looking tough.