What to do and not do during a market turndown
Never Retire Profile of the Week
Serena Williams
The average age in women’s tennis is about 27-years-old, but Serena Williams has never been average. On her way to setting numerous world records, Williams has come back from injuries throughout her career, played while pregnant in 2017, returned to tennis in 2018, and achieved a top-10 ranking in 2019 (at the age of 37). This year, she became the first woman in the professional era with at least one title in four decades: 1990s, 2000s, 2010s and 2020s. In her career, Williams has won 23 Grand Slam singles titles, the most by any man or woman in the Open Era, and is a four-time Olympic gold medalist. And, further defying the typical retirement age of tennis pros, she is the oldest player to reach a number one ranking and to win a Grand Slam singles title. Fans of tennis around the world have been dazzled by Williams’ talent and grateful for her staying in the game so long.
Bear markets make everyone nervous.
When rattled by downturns like we’re experiencing, investors worry as their portfolios shrink. Sometimes, that worry transforms into making decisions based on emotion rather than evidence, which is invariably a bad course. At Dri Financial, we always advise our clients not to react rashly to current market conditions but rather to keep their eyes on the long term. As the Oracle of Omaha – Warren Buffett – says, “Our favourite holding period is forever.”
Of course, you won’t necessary “hold forever,” but his point is to focus on growth over at least a decade. In our current situation with this coronavirus, we’re all going to see losses. But long term, the stock market has always delivered growth.
So in this downturn moment, let me offer seven tips for managing a bear market.
1. Stay the course
At Dri Financial, we start all new financial planning engagements with an Investment Plan (we call this an Investment Policy Statement. It outlines your time horizon (when you need the money), the types of investments that you will buy (bonds, stocks, alternative investments, illiquid investments, real estate, etc.), the portion (percentage) of your portfolio that will be allocated to each asset class, and your risk tolerance (how much of a portfolio decline you are willing to accept).
Because we are in a highly volatile period, let’s discuss risk profile more closely. Using the S&P 500 Index as a measure, there have been 16 bear markets (a drop of 20% or more from the previous high) since 1926, averaging once every six years. They last an average of 22 months, and the market loses an average of 39%1.
If we have a 30-year career and a 30-year retirement period, we can expect to pass through approximately 10 bear markets. That means we shouldn’t be surprised by them and that we must take them into account when preparing an Investment Policy Statement.
For example, let’s assume that you decided on an asset allocation of 30% bonds and 70% equities. Let’s also assume that during a bear market, equities drop by 40% and bonds rise by 5%. Given this scenario, the portfolio would yield a return of negative 26.5% during a typical bear market. In other words, $1,000,000 would drop by $265,000.
Historically, the S&P 500 has recovered from all past bear markets and eventually achieved new all-time highs. But that does not matter when you’re in the middle of a bear market, and it doesn’t make you feel any better.
When preparing the Investment Policy Statement and studying the potential loss in your portfolio, ask yourself, “Can I sit through this type of decline? Or would I be driven by fear to sell my position at the bottom of the market?” If the answer to the second question is “Yes, I would sell,” then go back and adjust the asset allocation towards a more conservative slant.
Let’s assume that a person lowers the equity component to 50% and increases the bond component to 50%. Based on the same assumptions, they would see a hypothetical drop in their portfolio of 17.5%. Would this lesser decline drive you to sell into panic? If so, you would keep lowering your equity component until you are comfortable.
When the next bear market occurs (and it will), you want to say, “I will stay the course.” And you will have confidence in saying this, because you thought through a bear market and you quantified how much volatility you could tolerate.
2. Rebalance your portfolio
Many studies have shown that consistent portfolio rebalancing helps the investor’s long-term investment performance. The Investment Policy Statement also outlines your desired asset allocation (say, 60% equities and 40% fixed income), maximum weighting of each stock (say, 5% in each stock), and the maximum range of fluctuation that you will accept before rebalancing.
For example, the Investment Policy Statement states that you will rebalance your asset allocation back to the 60/40 mix, if the mix fluctuates more than +/-5%. If equities decline to 43% and bonds increase to 67%, then you will sell 7% of the bonds and buy 7% of equities, thus returning to the preselected 60/40 mix.
Or perhaps the Investment Policy Statement states that you will rebalance each stock position that has an increase/decrease in weight of +/-2%. For example, if a specific stock declines to 3% weighting and another stock increases to 7% weighting, sell 2% of the over weighted stock and buy 2% of the underweighted stock.
During a bear market, you will be motivated to do something (especially if you are a Type A personality like me!). So instead of selling your stocks in a panic, rebalance you asset allocation and the individual weighting of each stock.
3. Harvest tax losses
Selling underperforming stocks (from a non-registered account only) triggers a capital loss that can be applied to capital gains during the past three years. Alternatively, it can be brought forward for an indefinite period and applied against capital gains.
This is a great example of making lemonade out of lemons.
4. Make sure you have enough cash
A market decline is usually followed by a recession, and a recession is usually followed by higher unemployment. So it’s important to have an emergency reserve of three to six months of monthly expenses in a guaranteed investment (for example, a GIC).
If you are retired, it’s also important to have two to five years of monthly expenses in guaranteed investments (GICs).
In both cases, the objective of the reserve is to prevent you from selling stocks when the markets are depressed and allowing them time to recover while, at the same time, the reserve ensures you have the necessary cash flow to pay your monthly expenses.
5. Do not look at your statements
With headlines full of pandemic news and its corresponding effect on the stock market, it’s very difficult not to look at your accounts (especially if you have online access). But I suggest you do not. Stay the course and, if necessary, rebalance your asset allocation and individual stocks.
6. Maintain your philanthropic commitments
As mentioned above, a bear market usually leads to a recession and job losses. So if your main concern is the decline in the value of your stock portfolio, consider yourself fortunate and maintain your charitable gifting. It doesn’t matter if you donate to a food bank, hospital, religious organization or any other cause. Just continue your gifting, as the need is greater during a recession.
7. Have a momentum strategy
At Dri Financial, we developed an investment strategy that buys the market when the S&P/TSX trend line is upward and sells the market when the trendline is downward. The result is that we are in the market when there’s positive momentum and parked safely in cash when the momentum turns negative.
Historically, our strategy flashes a buy signal close to market bottoms and flashes a sell signal close to market tops. It’s not perfect, but historically it has signaled the beginning of big selloffs. For example, during the current pandemic, the model flashed a sell signal on February 26, very early in the general market decline, avoiding the major decline in the indexes.
I hope you find these bear market tips useful. I’ll close with some timely advice for today’s environment.
- Prepare for the unexpected
At the time of writing this blog, the world doesn’t have a vaccine to defend against the virus. : During this pandemic, our thoughts tend to turn to our own mortality. We recommend that you review and make sure that your estate and insurance coverage are current and up to date.
I recently wrote about ensuring your Will and Power of Attorney accurately reflects your current wishes and re-evaluating your life and disability insurance. Have a look here.
- Expect revenue/income to decline
Most businesses have been impacted by the quarantine policies implemented across the country. Customers are not venturing outdoors and, when they do buy, mainly shop online and reduce their total expenditures.
The objective for many businesses is to stay relevant to their customers and stay solvent until the economy reopens. I suggest you investigate all government programs made available, such as the Canadian Emergency Response Benefit (CERB) for laid-off employees, the Canadian Emergency Wage Subsidy (CEWS), and the Canadian Emergency Business Account (CEBA) for business owners.
Also, re-evaluate your personal and business expenses and negotiate everything; try reducing and/or deferring a portion of your rent or mortgage. Also cut out unnecessary subscriptions and other outlays. You may also want to speak with your wealth advisor about you financial plan.
- Make use of this time
While quarantined at home, make yourself useful. Dan Sullivan of The Strategic Coach recommends that you stay “positive, present and productive” while at home. Consider using the extra time to prepare your business for its reopening. COVID-19 will likely be with us for some time, so how can we make our businesses “COVID friendly” for employees and customers? I believe customers and staff will return if they feel safe around other customers and staff. How can your business change to reflect our new reality?
I hope you find these bear market tips useful.
Stay safe out there, everyone.
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1Fidelity Investments. “Bear Market Basics.” Accessed March 20, 2020.