How horrifying are bear markets?
Photo by Daniel Jensen on Unsplash
Article originally posted here by Paradiem
You may not realize this, but bear markets are like a bad horror movie. You know, the ones that are so bad they end up on parody shows like Mystery Science Theater 3000? Once you’ve seen it, you can end up losing sleep for countless nights because although you know the movie is over, you can’t shake the bad thoughts and memories from the event.
Our memories often confuse us and leave us in a place of being more fearful than we should be. Each movie is unique, just as each bear market is unique, but in the end, most of them follow similar formulas. One thing I’ve learned is, the fear of something begins to go away when I know the formula and how the movie (or bear market) turns out.
I cannot tell you how many times people begin conversations with how devastating bear markets are. If you know what you’re getting into, you can prepare and survive any bear market. If you know what to expect, the overall effect of a bear market is less devastating than your memory or the media might lead you to believe.
There are three perspective shifts that are important to preparing your mind to survive any future bear market.
First, an investor should set aside enough cash from the portfolio to survive five years of expenses. Said another way, you should never invest any money you know you might need access to in the next five years.
Bear markets are not predictable, but we find they typically happen one year out of every five.[1] By setting aside the cash for that five‑year period, you give yourself an opportunity to create a reserve that will allow you to survive when an unexpected bear market happens.
Second, you must carefully manage the cash reserves through the post-bear market recovery period. You’ve set aside five years’ worth of cash so you don’t have to sell your stocks when they’re at their low. As the market drops, you can live off the reserves until your stocks have time to recover.
Five years is not a hard‑and‑fast rule, but I’ve found that it gives you the flexibility to survive the uncertainty. As the recovery begins you can wisely determine how to replenish your reserves.
I remember specifically using this strategy in the 2008 market drop. Many of our clients had consumed four years of cash and were down to their final year before we saw enough recovery to begin selling stocks. We didn’t re-build the cash position over night, but over the next three years we were able to use the increasing market to re-create five years of cash position as the market continued its recovery.
Third, you must realize most bear markets recover faster than anyone expects. Historically, the average recovery from peak to peak of a bear market is 40 months.[2]
This means when you are at a peak and things begin to go down, the market will, on average, begin new highs again in a little over three‑and‑a‑half years. If you have five years of cash on hand during that period, you certainly have enough cash to survive the average bear market.
Despite what the distracted media will tell you, we’ve had two bear markets since 2008. In 2011 and 2018 the markets dropped more than 20% from their peak. In each instance, those markets had recovered all their losses within six months.[3] The memories of most bear markets are often more devastating than the reality and most investors are surprised when they hear how quickly these bear markets recover.
The news media wants you to believe bear markets are so devastating that you would never be able to survive one, and therefore, you need to do act to avoid them. As you can see, surviving a bear market is easier than most would expect. Just like watching a bad horror movie, once you know the formula, the fear begins to subside. The secret to your long‑term success will be driven by owning great companies and knowing how the movie ends.
At Paradiem, we hate “investing” and think you should too! We are not just investors; we are OWNERS and we believe WHAT you own and WHY you own it is a much more important consideration. If you would like more information on the importance of understanding what you OWN, email info@paradiem.org with the subject “Ownership” or give us a call at (985) 727-0770.