Contributed by: Center Investment Department
In a Q+A, our Director of Investments Angela Palacios, CFP®, AIF® provides valuable advice on the dos and don’ts of investing in a bear market. A “bear market” is when assets fall at least 20% or more from their high. We are currently facing a bear market.
What is a bear market and what triggers them?
A variety of situations can cause a bear market. They can be event-driven, which explains the current bear market. A black swan event like COVID-19 or a shock in commodity prices like the price war on oil can cause bear markets that lead to recessions. In the case of late 2018, that brief bear market was driven by the trade-war escalation. This example did not lead to a recession. Financial imbalances like high inflation, increasing interest rates from the Federal Reserve, or banks being too leveraged (like in 2008) are all issues that can trigger a bear market and lead to an eventual recession.
What's good/bad about investing in a bear market?
Data from historical bear markets indicate that they are excellent investment opportunities, however, it is the most difficult time to invest. Bear markets allow us to tax-loss harvest to offset future capital gains, ultimately reducing our tax bills. We can rebalance out of positions that may not be our highest conviction investing ideas that we have had to hold on to due to high capital gains embedded in those positions.
What investments are best for a bear market and why?
We believe “Core Fixed Income” is often the best strategy to offset the downside risk from equities. These include positions like U.S. Treasuries and High-Quality Corporate debt. Generally, when equities are going down, investors are buying these types of investments. Cash is also a good insulator during times like this. Even though interest rates are low, there is no substitute for its safety. It is very important to always have your next 6-18 months of cash needs set aside so you don’t have to liquidate during times of market turmoil.
What should a brand new investor know about building a portfolio in a bear market? Is it a good time for newbies to enter the market while prices are down?
Start building a portfolio regardless of whether we are in a bull market or a bear market. The old saying goes, “Time in the market is more important than timing the market”. Most investors save systematically throughout their lives rather than investing in one lump sum. We save every month through our 401(k) deferrals or every year when we get that bonus from work. Dollars go farther in bear markets because the shares of the mutual fund you are buying are now on sale. Investing is the only time in life when buying something on sale doesn’t feel good, but it should if you have a long time horizon to save.
What advice do you have for managing a portfolio in a bear market and when it begins to turn bullish again? For example, how do you manage risk and asset allocation to stay on target with your goals?
The investing strategy and financial planning goals should be developed during quieter times. Thinking ahead to how you should react during times like this is crucial because in the moment our emotions are very difficult to overcome. A rebalancing strategy also needs to be developed at the same time you are developing your investment strategy. It is a concept that sounds simple but can be very easy to neglect. When markets are doing great and there is very low volatility (like January of this year), you may be tempted to let your best-performing investments run just a little bit longer before rebalancing…meaning you hold your stock positions rather than rebalancing into bonds. In other years that may have been fine, but this year it was not. So, having thresholds around how much stock and bonds you have in your portfolio can take the guesswork out of when to rebalance. That is extremely important at the depths of a bear market because one of the best ways to help your returns coming out of a bear market is simply to rebalance back to your target allocation of stocks and bonds. When markets are down, this means selling bonds and buying stocks.
We hope you found this informative. If you have additional questions, please contact your advisor!
This material is being provided for information purposes only. Past performance doesn't guarantee future results. Investing involves risk regardless of the strategy selected, including diversification and asset allocation. Rebalancing a non-retirement account could be a taxable event that may increase your tax liability.