Financial Tips

Published 12:00 am Wednesday, April 25, 2001


A primer on the bear stock market Mention the phrase bear market, and you’ll find many people in a panic. However, bear markets are a regular part of the market cycle. These market declines of 20 percent or more occur on average every three years. While no one looks forward to bear market declines, trying to avoid them may be the worst investment strategy you can elect.

Is it Time to Run?

Many times when investors see falling stock prices, they feel panicked and rush to sell without realizing the consequences. Consider the crashes of 1974. If you were a long-term investor before the crash of 1974, being scared out of the market by a bear would cost you millions. As an illustration: $100,000 invested in 1964 would grow to more than $170,000 just before the crash. If you sold at the depth of the bear market in September 1974 and invested the remaining $105,000 in CDs, it would take your account more than six years to recover from the loss. By October 2000, your account would total $721,340. On the other hand, your account would recover from the crash in 15 months if you stay invested in the market. By October 2000, your account would be worth $5.5 million. By running away from the bear market, you would miss out on nearly $5 million dollars.

Maybe Just for a While…

What if you don’t run away entirely, but only sideline yourself for a period of time? The average annual return from 1926 to 2000 is about 11 percent. If you were to pull out of the market periodically in an attempt to time the market, you would probably miss some of the months of recovery. If you missed the five best months, your average annual return would be decreased to 9.7 percent. If you missed the best 15 months, your average annual return would dwindle to 7.3 percent. Trying to time the market for maximum gain and minimal loss is called market timing. Market timing is also not the answer for surviving a bear market in the best possible condition.

The Odds are in Your Favor

Even though previous returns are no guarantee of future results, they do provide interesting information about the market. The frequency of a 20% or more decline in the Dow Jones Industrial Average is about once every three years. A bear market is a prolonged 20 percent or more decline. While no one likes the idea of losing 20 percent or more of his or her portfolio, these declines are normal occurrences. Even with the occasional decline, staying invested in the market has proven to be the best strategy when surviving a bear market.

What Can You Do?

The best first step you can take in surviving a bear market is to stay calm and stay invested. Remember that some of your investments will not be affected by a bear market. For those that are affected, it is important to think about the tax consequences of selling the investment before you take any action. Sometimes the tax liabilities will eat more of your investment than riding out the decline. It is also important to remember the value of long-term investing. If you won’t need your money for a number of years, day to day fluctuations should not concern you. As long as your long-term plan is in good shape to meet your goals, time is your ally. Holding an S&P 500 stock for 10 years has resulted in gains 97 percent of the time.

Working with a Financial Advisor

Having a long-term financial plan is the best way to build and maintain financial independence. If you don’t know where to start or need help with creating a diversified financial plan to help you meet your goals, you may want to consult a financial advisor. A financial advisor has resources and experiences to help you during a bear market. Your advisor can guide you through strategies like diversification. Another important decision for you to make with your financial advisor is whether or not to add to your investments. For some investors, a bear market is a great opportunity to add to holdings by buying stocks at lower prices or adding to more stable investments like bonds. Finally, an important highlight to remember about bear markets is that they eventually go away and are followed by market gains. These market gains are important times to be invested to get the best possible return on your investment. ALAN S. MOORE is a Financial Advisor with the Mandeville office of Legg Mason, a diversified financial services company.