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We have just reached a new bear market due to the fears of the coronavirus pandemic. The chances are that this is your first bear market. And the chances are that you are freaking out.
Today, I want to cover how to invest in a bear market and what to do when a bear market strikes.
But first of all, you should focus on your health with this coronavirus. I hope you and your family are healthy! Money is useless if we are not in good health to enjoy it! Make sure you follow the rules set by your country and your company. And remember that while you may not be at risk with this virus, many people are! Do not spread it further!
Once you have taken care of your health for the near future, let’s see what we can do with our investments in these trying times.
Let’s start at the beginning: What is a bear market?
A bear market is a state in which a stock market is when it has lost 20% since its high. The bear market will persist until the market is back to where it started before the drop.
The duration of a bear market can vary a lot. Some have lasted a few years, but some have laster for several years. On average, bear markets have lasted nine months.
On March 11th, the U.S. stock (and most of the world stock markets) entered a new bear market after falling more than 20%. This event stopped a bull market of 10 years, the longest bull market in history.
This bear market also shows a swift entry. It only took a few weeks to fall by 20%. Historically, it took much longer to drop that much. It could indicate that this bear market will be short-lived. But nobody knows that yet! We will have to see how it goes!
Before that, the previous stock market occurred during 2007 and 2009, caused by the subprime mortgage crisis. During this time, the S&P 500 lost about 50% of its value.
Do not panic during the bear market
The most important thing about investing during a bear market is not to panic. The worst thing you can do is panic and sell all your shares.
Remember that you are in the stock market for the long-term. Stick to your plan!
Also, bear markets have always occurred in history. The stock market is cyclical. We just went into a new cycle. And this new cycle was long due. You knew that when you started investing. And you still know that now. Investing in a bull market is easy. It is during bear markets that investors are making mistakes.
There are a few things you can do to help yourself during these trying times:
- Do not check the stock market every day
- Remind yourself that paper losses stay on paper until you realize them
- Remind yourself that bear markets have always ended. On average, the stock market has been going up.
- Remind yourself that this is something that already happened, and that will happen in the future again.
Do you know what you should do if you encounter an actual bear in a forest?
You should play dead. There is no point in fighting a bear. And running away from him will just encourage the bear into making you into his lunch. And we do not want that!
It is the same during a bear market. Stay calm and just wait until the bear market is over. It will go away. You just have to wait for it and endure it. It may take months or years, but the stock market will recover.
Do not time the market
Once a bear market starts, many people try to sell their stocks and buy them later. By doing that, they can purchase shares at a lower price than when they sold, hence making a profit.
You should not attempt that! Most people that are doing that end up buying higher than they sold. Or simply, the stock market will directly jump higher after they started selling.
And you have to consider the transaction costs of doing that. Buying and selling are not free actions!
Doing that is pure market timing. You should not do that. A few people may win at this game (gamble!), but most people will lose money!
Do not stop investing during a bear market
One thing that a lot of people do during a bear market is to stop investing! You should continue investing.
If you are investing for the long-term on a monthly (or more) basis, you should continue your investments.
For a shopper, a bear market offers some exciting discounts. You need to take advantage of them. If you are investing for 20 years in the future, it is better to buy at -30%! If you believe in buying shares at 100% of the price, you should still believe in buying shares at a 20% discount!
Continuing to buy can make a significant difference in recovering from the bear market. It does not make sense to stop investing. Now is the best time to invest!
Stick to your plan and allocation
Many people try to change their asset allocation during a crisis. For instance, some people try to increase their bond allocation.
But this is not a good time to do so. There could be good reasons to change your asset allocation. But doing that because the stock market is going down is not a good idea.
You need to stick to your asset allocation. It was right when you decided on it. It is still good now! Staying the course is a vital part of any plan.
After the crash, if you felt you had too much stocks (or too much bonds), you can always change your asset allocation and rebalance. But do not do that during the crisis.
Also, if your plan includes rebalancing, you need to continue rebalancing even during the bear market. For instance, as stock fall, you may want to sell some bonds to purchase more stocks. Rebalancing will help you in the long-term.
Use extra cash (if any)
If you have some extra money available, it may be a good time to invest it.
You should not invest your emergency fund! This one needs to be kept ready. And you need to make sure that your emergency fund is full and adapted to the circumstances. Your emergency fund is not for investing!
If you are investing regularly, why would you have extra cash?
A lot of people are keeping extra cash when the markets are at very high valuations. This extra cash is sometimes called an opportunity fund. Once a bear market stats, it is a perfect time to invest that extra cash at a discount.
One thing you have to decide is: at which point will you invest? You need a strategy. You could use a simple threshold strategy:
- Invest 25% of your cash at -20%
- Invest 25% at -25%
- Invest 25% at -30%
- Invest 25% at -35%
Or you could follow an ETF, and each time its price goes down by one dollar, you buy 10K USD. There are many strategies like this. And you can even make your strategy part of your Investor Policy Statement.
Keep it simple
When the market is going down, there are a few investing techniques that you take advantage of. These are complicated and risky instruments, and I strongly encourage you not to use them!
If you are a passive investor, you should keep investing like you always did. There are no reasons to change just because you think you can make a quick buck.
Some people are trying to find stocks that will endure during a crisis. For instance, some companies are more vulnerable to a virus than others. But if you are passive investors, just stay the course and continue investing in your portfolio.
In a bear market, Inverse ETFs are doing very well. These ETFs are doing the inverse of an index. When the index goes down, the ETF goes up and vice-versa. But using this form of ETF is just market timing. When are you going to sell? When is the market going to reverse? You should avoid this!
Another thing you should avoid is short selling. It means you borrow shares, sell them immediately, and hope to repurchase them later cheaper before you return them. It is quite dangerous because if the stock market goes up, you can make a significant loss. Short selling is significantly riskier than merely investing in stocks.
Another thing you could do is invest on margin. Using margin means you borrow money to invest in stocks. By investing with other people’s money, you will increase your returns if all goes well. But if it does not go well, you will also multiply your losses. It is very dangerous. I would also strongly recommend that you avoid doing that during a bear market.
Another thing you should avoid as well is using options! There are many ways to use options to profit from a down market. But these are incredibly complicated instruments and extremely risky as well. Do not try these just because you read somewhere that they are a way to invest in the stock market.
During a bear market, you need to keep it simple! Just because the market is going does not mean you should change your investing techniques.
A bear market may be a scary thing. But if you do not panic and follow a few simple rules, you can get out of it stronger than you were!
The most important thing is not to panic. Do not sell your shares! Do not try to time the market. During the bear market, continue investing as usual. And use the extra cash you may have to reduce your average price.
Keep in mind that bear markets are normal. There have been many bear markets in the past, and there will be many in the future. We need to live (and invest) with them.
During any bear market, you should continue doing what you were doing before. Do not make any change in your investing strategy or your asset allocation. It is not a good time for this.
I hope you will trade safely during these troubled times and keep being healthy!
Once this bear market will be over, there are a few things we can do after a bear market.
A bear market does not mean we are in a recession. You can learn more by reading my article about recessions.