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richie

How to benefit from a bear market

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Use this not as financial advice. After 10 years of rising stock prices we also need to take a look at how we can benefit from a bear market. We can all learn from it.

 

A decline in the market should be a great financial gift if you can keep saving as well as investing.

Either by reinvesting dividends or adding new savings, a bear market permits you to invest at lower prices.

If you could pick from three possible stock market instances: In the first, the stock market rises steadily in a straight line for three decades. In the second instance, you face periodic bear markets over the three decades. In the third, for many years stocks remain in a specific position and then rallies strongly close to the end of the 30 year period. In the three instances stated above, the market averages ends at the same level, with the path taken to get there as the only difference.

The best scenario out of all three is the third, because it gives you the opportunity to purchase stocks at lower prices, on average. The first scenario is the worst, while the second is somewhere in between.

Buying stocks continuously and refusing to sell, will enable you to have more bear markets during your saving years, and the higher the probability of retiring with a larger nest egg.

 

Our true risk tolerance can only be learnt by living through bear markets 

The celebrated 1940 book about Wall Street titled: "Where are the customer's yacht?" and written by Fred Schwed. In this book, he gave this passage to remember: "Like all of life's rich emotional experiences, the full flavor of losing important money cannot be conveyed by literature. You cannot convey to an inexperienced girl what it is truly like to be a wife and mother. There are certain things that cannot be adequately explained to a virgin by words or pictures."

It’s difficult to tell before hand how you’ll feel and behave if you lose a large sum of money in the stock market. Your returns on investments made is largely dependent on your asset allocation. Taking more risks and allocating more to stocks, in the long run it will be transformed into greater returns.

While investing, one important thing to note is to understand yourself, because we are our own worst enemy. The only way to discover the mix of stocks and bonds we are able to live with, is to live through a bear market.

 

Bear markets puts an end to bull market foolishness.

Asides higher stock prices that makes investing riskier, the euphoria that results sucks more people and more money into the market at a very wrong time.

Perhaps, the only sure thing in investing is the market’s cyclical nature and human psychology. Optimism spreads like a disease. You may feel your decisions are made independently, but when the economy runs well and optimism is rampant, then it’s difficult to resist the herd mentality. This is exactly how we get wired.

Your portfolio in the short run will definitely be dented by a bear market, but in the long run might save you even more – if only you are prevented from being a victim of future market euphoria and the risky behavior that occurs frequently.

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