8 steps you can take now to prepare for the bear market

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The U.S. stock market is at (or near, depending on the day and the hour) its all-time high, and we’re all so used to this situation that we hardly notice any more.

Since this long recovery began in 2009, the market has recorded more than 200 all-time highs.

This suggests some interesting questions:

• Is a bear market just a ho-hum topic?

• Is the concept of risk out of date?

• Are we in a “new era” of endless investment prosperity?

Personally, I don’t think so. But don’t take my word for it.

Warren Buffett: “Be fearful when others are greedy, and be greedy when others are fearful.”

Sir John Templeton, founder of a family of funds that bear his name: “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.”

I thought about all this at length on a cross-country flight a few weeks ago after speaking at an investment conference in Florida. There was plenty of talk at the conference about the potentially exciting times ahead for investors. But also an undercurrent of concern that a huge bear market that could wipe out much of the gains that everyone seems to be enjoying.

If the future turns out to be full of great investment returns, you won’t need any advice from me. It will be easy to accept your good fortune.

But you should know that bear markets — defined as market drops of 20% or more — are normal. You should expect them.

In my experience, many reasonable investors can accept losses of 20% and stay the course.

But how do you feel about losing nearly twice that much in just one calendar year?

In the two bad years of 1973 and 1974, the S&P 500 index SPX, +0.34%  lost 37.3%.

Ancient history? Already in this century, that has happened TWICE: a cumulative loss of 37.6% in 2000 through 2002 and a 37% loss in 2008.

When you ignore the calendar and measure from peak to bottom, the loss in each of these three bear markets was around 50%.

You can see that graphically in this amazing graph.

In all these cases, the market started down abruptly while the majority of investors were euphoric. That’s typical.

In that graph you can see something else that might seem counterintuitive: Young investors should welcome a bear market, for it gives them an opportunity to buy equities at lower prices while others are bailing out.

But older investors should take the prospect of a bear market seriously. Very seriously.

One of my favorite authors, Jason Zweig, wrote an article in The Wall Street Journal recently about the crash of 1929 and the subsequent losses.

On the reasonable assumption that stay-the-course investors did not reinvest their dividends, he shows that the market didn’t recover its 1929 high until 1954.

“To this day, no one is sure why stocks crashed in 1929,” Zweig wrote. “No one foresaw how long and terrible the bear market would be.”

In Zweig’s view, “Investors should always regard the stock market as sailors regard the sea — a means to an end, usually benign, but potentially lethal.”

I share that view. Here are eight steps you can take now to prepare for the bear.

1. Recognize that nobody can know the future. Hundreds of pundits and salespeople will try to convince you they know what’s coming. But predictions are cheap, and the ups and downs and ins and outs of the market offer a lifetime of rationales for making bad calls.

2. Invest on facts, not emotions. When the bear hits, your emotional response is likely to do you more harm than good. Again, Warren Buffett: “Other people’s fear is your friend, because it drives the price of stocks down. Your own fear is your enemy.”

3. Expect bad times. At the bottom of this table of returns from 1970 through 2018, you’ll see real-life examples of the damage that investors must live with if they choose an asset allocation and stay the course.

Those who stay the course are likely to recover. Those who bail out may wind up adrift and susceptible to salespeople who pretend to know the future — but who don’t.

4. Protect your portfolio with fixed income funds. The table I referenced above shows a range of results from various combinations. Owning fixed-income is a powerful way to reduce your losses and help you stay the course through the rough seas that were alluded to above by Jason Zweig.

This is vital: For this to help, you have to do it now, before the bear growls. Like insurance, this is protection; you can’t buy it after you have a loss.

5. If your goal is to achieve the highest return within your risk tolerance, refer back to that table. Find a column with losses you’re willing to live with, and let that allocation guide your portfolio.

If your goal is to find the lowest-risk way to meet your needs, figuring out how to do that gets considerably more complex because you need to accurately determine — or project — your cost of living.

In this task, you will likely benefit from item No. 7 below.

6. If you’re already retired during a bear market, take your distributions on a variable basis, a fixed percentage of what your portfolio’s worth instead of a fixed dollar amount. To do that you will have to learn to tighten your belt in bad times. But the payoff is that you will vastly reduce the chance you’ll run out of money.

The suggestion in my next point could help you implement this.

7. If all this seems daunting, enlist the help of a competent adviser who does not sell products and has no conflict of interest. This will cost you some money, and of course I always recommend keeping your expenses low. But the cost of having a good adviser on your side could be the best money you ever spend.

8. Turn off the TV.

I’ve seen far too many people obsess about the market, in good times and bad, and the most likely outcome is that:

• They get worked up with agitation that generates fear or greed, which lead them to make bad choices.

• They squander time and energy worrying about things they cannot control instead of using that time and energy doing things they like to do and enjoying their family and friends.

There’s much more to say about bear markets, and I’ve recorded a podcast called “How to invest in a bear market.”

Richard Buck contributed to this article.

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