It’s not the pain of losses that drives many investors to sell, but the fact that they do not know when the pain will stop. The uncertainty creates anxiety that can lead to poor investment decisions. Because investors never know precisely when we’ve hit the bottom, many will sell when they can no longer stomach any additional pain. The good news is that with the right approach and guidance, bear markets (a loss of 20%+) can present opportunities for investors.
It is important that there is a clear game plan in place to deal with challenging market cycles. Perhaps most importantly, investors must live to fight another day. The risk during a bear market cycle is not that prices are declining, but that an investor may be forced to sell during those declines. Retirees, for example, may be forced to withdraw assets to cover expenses and Required Minimum Distributions from retirement accounts. This could be disastrous for someone with twenty or more years to go into retirement. Not only are investors impacted by selling stocks at distressed prices, but not holding those shares during a subsequent recovery period may further hinder portfolio growth. Consequently, having a distribution plan is critical to the long-term success of an investor’s portfolio. Whether you follow the more current Modified Safe Withdrawal Method or another withdrawal methodology along with a diversified portfolio, ensuring that enough bonds and cash are in place to provide for many years of income, an investor can offer the most valuable asset of all time.
When putting money into the market, often the first question investors ask: what should they buy? Before this question can be answered, there is an even more important question to consider: How will we buy? During a bear market cycle, it is perhaps most important to choose the right investment vehicle to reach goals and objectives. Mutual funds can be useful in that they allow investors to access a diversified portfolio with a small amount of investable assets. Mutual fund investors, however, do not own the underlying assets, they own shares in the fund. As other investors in the fund are running for the exit, they must be returned cash for their redeemed shares. The investors who remain invested in the mutual fund are then penalized for the bad behavior of others. Not only are mutual fund managers and those remaining investors being forced to sell the underlying assets at the worst possible time, but they may also realize gains in non-tax deferred accounts. For many high-net-worth investors, owning individual securities in a separately managed account may offer many unique benefits such as customization, flexibility, and the ability to manage taxes.
In recent years, the outperformance of more volatile growth stocks and cryptocurrencies, particularly in the 18 months that followed the March 2020 lows of the pandemic, made it seem that the “HODLers” (HODL stands for Hold on For Dear Life) may have been onto something. Over a long enough time horizon, perhaps this more stomach-churning strategy could work, but from where we collectively sit today, it seems unnecessary. Rather than HODLing, investors should be encouraged by the opportunity to invest in assets that provide the ability to compound in order to see themselves through the current cycle. A simple question to consider is: “How much am I being paid to hold these assets?” Stocks that pay healthy, increasing dividends year after year allow us to benefit from the compounding effect of their dividend. Interestingly, these stocks have a habit of being less volatile and more resilient. It could be a prudent consideration to become a “Compounder” rather than “HODLer” in bear markets like this because most of these stable dividend payors maintained their dividend or increased their dividend this year. This free cash flow may be the breath of fresh air needed for many investors.
Bear markets may provide opportunities to come out with a more durable portfolio. However, human beings are hard wired to avoid pain. It is our nature. For investors, consider adjusting the portfolio’s management style to reflect the following three principles: avoid selling unnecessarily; the investments structure matters; and cashflow from your portfolio creates additional opportunities.