How to Handle Bear Markets

With all the uncertainty around geopolitical events, inflation, and interest rates, investors continue to shy away from stocks.  As of the writing of this update on March 15, 2022, the S&P 500 is down about 13% from its previous high and the Nasdaq is down about 18%. Investors aren’t done sorting through what ails the economy, and there could be more downside exposure for markets.  While no one likes bear markets, how you handle them has big implications for both building and living off your wealth.

Acceptance

One of the hardest things to accept as an investor is that bear markets happen.  We all hope they won’t and it’s more comfortable to avoid thinking about them. But they have been part of the investing experience since its inception, and they aren’t going away. Thus, it’s helpful to have a plan for how to handle them.

Below is some research conducted by Beacon Pointe’s Investment Research Team. The chart illustrates the average intra-year price declines in the S&P 500 going back to 1980. From the chart, you can see price declines happen quite frequently. In fact, 34% of the time there has been an intra-year decline of 17% or more. We also had 11 declines (highlighted in green) worse than 17%, with the most severe being -49% during the financial crisis. That’s the first part of the bear market story.

How to Handle Bear Markets
As of February 1, 2022 S&P 500 Index. Max drawdown represents the biggest intra-year decline. Source: Bloomberg, Beacon Pointe

 

You also know, and many of you have lived the second part of this story, which is that every time markets have declined, they have also recovered. So why do we get so worried about bear markets when they happen?

Nagging Suspicion

It’s because there is always a nagging suspicion that maybe this time the market won’t recover. Or maybe the market recovers, but it takes 20 or more years like it did during the Great Depression.  It’s important to acknowledge these risks because they do exist. As we all know, there are no guarantees in the markets. History is informative for investors, but it’s not determinative.

While concerns over longer-term declines are rational, we have to ask what the odds are of this type of decline.  Part of the game of investing is to understand that investing is about assessing a series of probabilities for success and failure. Nothing is certain, but some things have much higher probabilities of success than others. In general, you should structure your portfolio for the higher probability events.

Invest For Higher Probabilities

Therefore, we can ask, what’s the probability the market will recover within, say, five years? We can’t put a precise figure on it because the stock market does not have a limited number of potential outcomes, such as we have with rolling dice. But based on history, we can say it’s roughly over 90%.

Conversely, what are the odds it won’t recover within several years? Maybe around 10%. So, which of these probabilities do you want to focus on?  Again, intellectually, the answer is clear – you invest for the 90% probability. It would not make much sense to structure your portfolio around the 10% probability.

Defense

But what about that 10%? It’s not nothing and the consequences are not good if the market doesn’t recover in a reasonable period of time.  Well, that’s where your defense comes into play. Things like cash, bonds, other less volatile investments (such as public or private real estate, for example), and some income-producing equities are there to help manage this 10% issue.

How Much?

We have discussed this before, but time horizons matter a great deal with respect to how much defense you need. If you are 25 and are going to let your 401(k) money sit there for 40 years, you don’t need much defense.  But as you get older, have more at risk, and eventually need to live off the money, then you likely need more defense. And we do adjust our risk profile for retired clients as market conditions change. But they are generally modest adjustments around the changing probabilities, not wholesale exits from markets.

Having a Plan

Thinking through the amount of defense you need and having a plan of action helps neutralize the uncomfortable bear market feelings and allows you to invest more rationally. That’s the key to getting through bear markets.

It is important to keep the basic framework in mind:  we want to invest for that 90% probability of recovery yet implement strategies to mitigate the 10% risk of a longer bear market. And that 10% risk is most applicable to those investors who may need access to their capital during any recovery.

As always, we appreciate your trust and confidence in our guidance. If you have questions about your portfolio or allocation, don’t hesitate to contact us.  We are here to help manage the funds to your unique objectives.

RELATED LINKS:

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Important Disclosure: This report is for informational purposes only. Opinions expressed herein are subject to change without notice. Beacon Pointe has exercised all reasonable professional care in preparing this information. The information has been obtained from sources we believe to be reliable; however, Beacon Pointe has not independently verified, or attested to, the accuracy or authenticity of the information. Nothing contained herein should be construed or relied upon as investment, legal or tax advice. All investments involve risks, including the loss of principal. Investors should consult with their financial professional before making any investment decisions. Past performance is not a guarantee of future results.

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