Know Your Number to Prepare for a Bear Market

Know Your Number to Prepare for a Bear Market

June 27, 2019

The stock market hit new highs this month. Yet many investors remain undeniably gloomy.

Economic expansions and bull markets don’t die of old age. (Just ask any Australian under the age of 28; that country hasn’t seen a recession since 1991.) But with the bull market plowing through its tenth year, many market watchers are ready to leap on any signal—such as the yield curve inversions we saw earlier this year—that hints a turn for the worse is on the horizon.

Perhaps, then, it’s a good time to think about what an investor should do when the bear starts to roar. Or in other words, what’s your number? By “number,” we don’t mean how big you want your portfolio to be heading into retirement. Rather, what dollar-value or percentage decline in your investment accounts would send you running for the hills?

After all, the standard definition of a bear market is a drop of 20% from a recent high. That’s enough to take a million-dollar portfolio down to $800,000. And while 20% may be the minimum decline that defines when the market has turned from bull to bear, most bear markets see deeper nadirs. On average, the peak-to-valley during past bear markets has been 35%, a hit that would take that million-dollar portfolio all the way down to $650,000.

Dips like that are enough to make any investor’s eyes water. But does that mean that the right thing to do is lock in gains now and retreat to more conservative investment strategies? Not necessarily.

There’s a reason we here at Adviser Investments suggest that it’s time in the market, not market timing, that makes the difference. Because while the market tends to eventually recover from dips, it doesn’t do so smoothly. And while all those herks and jerks can make for a bumpy ride, missing out on even just a few of the short-term jumps can do long-term damage to your portfolio.

How so? Consider the chart below. The darker blue line shows the returns you’d have earned by investing $10,000 in the S&P 500 Index just under 30 years ago (with dividends reinvested). The bright blue line? That same $10,000 investment in the S&P, but missing just 10 days of gains—the market’s 10 best single-day returns.

Note: Chart shows hypothetical returns of a $10,000 investment in the S&P 500 total return index from 12/31/1989 through 6/20/2019. Missing Best 10 Days line assumes a 0% return on the 10 days with the biggest percentage gain for the Index over the period. Sources: YCharts, Adviser Investments

That simple difference was enough to put a $77,000 dent in our market-timing portfolio. An investor who didn’t move a muscle during the good times and bad would have turned their $10,000 investment into $153,816 in 30 years. But take out the 10 best days, and that same $10,000 becomes only $76,763—less than half the gains.

Of course, it would take some improbable luck to miss all 10 of these positive outliers, just as it would be equally improbable you’d be able to get in and out of the markets for the worst days over time.

But it does show the danger in trying to time the markets: Being even a day or two late to the party when good times return can mean you miss out on a large proportion of the market’s positive performance in recovery.

Risk is a fact of life for every investor; finding a level of risk you’re comfortable with is what’s key. And it’s not every investor who has the luxury of waiting a half a decade or more for stocks to recover from a crash. If the prospect of a decline in the value of your portfolio is keeping you up at night, it may be time to reach for a phone instead of an antacid tablet and talk with a financial adviser.

They can help you look at the broader questions—your needs, your goals, and how they compare with your overall portfolio. As your life changes, your investment goals will change, too.

To learn more about how to deal with the possibility of a portfolio decline, click here to listen to Chairman Dan Wiener and Director of Research Jeff DeMaso discuss the topic in the “What’s Your Number? episode of The Adviser You Can Talk To Podcast.

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