Where do investors tend to put their money in a bear market?
A bear market is traditionally defined as a period of negative returns in the broader market to the magnitude of between 15-20%, or more. During this type of market, most stocks see their share prices fall, often substantially. There are several strategies investors employ when they believe that this market is about to occur or is occurring, and they typically depend on the investor's risk tolerance, investment time horizon and objectives.
One of the most conservative strategies, and the most extreme, is to sell all investments before the downturn begins or before it hits its lowest point, and either hold cash or invest the proceeds into much more stable financial instruments, such as short-term government bonds. By doing this, an investor can attempt to reduce his or her exposure to the stock market and minimize the effects of a bear market.
But this strategy requires knowing when to sell, and bear markets can be very difficult to predict. As Ryan Miyamoto, a CFP® in Pasadena, CA, explains, “Selling at a loss is your biggest threat. A bear market will test your emotions and patience… The best strategy to control your emotions is to have a game plan. Start by creating a safety net that is not invested in the market. Seeing your accounts go down will be a lot easier if you know you have adequate cash on hand.”
Paul R. Ruedi, a CFP® financial advisor in Champaign, IL, suggest investors regularly do “lifeboat drills” before a bear market starts. He says investors should “...imagine a bear market has occurred and the stock portion of their portfolio is down 20% or 30%. How will they feel? How are they going to react? Are they going to panic, or remind themselves that “this too shall pass,” and stay the course with their investments? We remind our clients to do these all the time, and when a bear market occurs, they are spared the panic and emotions that consume most investors during bear markets.”
For investors looking to maintain some positions in the stock market, a defensive strategy is usually taken. This type of strategy involves investing in larger companies with strong balance sheets and a long operational history, which are considered to be defensive stocks. The reason for this is that these larger, more stable companies tend to be less affected by an overall downturn in the economy or stock market, making their share prices less susceptible to a larger fall. With strong financial positions, including large cash holdings to meet ongoing operational expenses, these companies are more likely to survive downturns. These also include companies that service the needs of businesses and consumers, such as food businesses (people still eat when the economy is in a downturn) and companies that sell basic consumer goods (people still need to buy toothpaste and toilet paper). In this same vein, it is the riskier companies, such as small growth companies, that are typically avoided because they are less likely to have the financial security that is required to survive downturns.
As Benjamin Westerman, CPA/PFS, CFP® in St. Louis, MO explains, many investors look to bond holdings and cash during a market downturn. “Bonds are your “sleep at night” money that is protected during a bear market, while you wait for your investment portfolio to recover. In addition, if you have any money on the sidelines or are still in the accumulation/savings phase of your life, this is a great opportunity to invest in equities while stocks are on sale.”
As investors will find, there is a wide range of other tactics that can be tailored to a bear market. The most important thing is to understand that a bear market is very difficult to predict, and to remember that most strategies can only limit the amount of downside exposure, not eliminate it entirely.
The answer to the question of where DO investors put their money and where SHOULD they put their money give two very different answers.
Where DO they put it? The thing about bear (and bull) markets is that you don't know that you are in one until you are pretty deep in one. So, once average investors have figured it out (which could be way more than half way through its cycle), they panic, sell stocks, and go to cash and short term bonds. Some try to seek out uncorrelated assets like certain commodities and real estate. The more reckless ones buy inverse triple-leveraged ETFs, but they are so beyond help, we won't bother addressing them.
This is all futile. Market timing does not work. Don't herd with a crowd that loses money all the time. In the last 30 years, the US stock market has returned an average of 10.35% per year, while the average US investor has made 3.66% per year. The majority of the difference between those two numbers is a result of behavioral mistakes revolving around market timing.
From a logical perspective the perils of attempting to exit the market before it goes down are well documented. However, when asked: What do investors collectively tend to do during a bear market? We see that they often react by pulling money out of the market and flee to shorter term fixed instruments such as money market funds or CD’s. According to the Investment Company Fact Book, during the 2008 downturn investors withdrew $211 billion from mutual funds, while money market funds saw a net increase of $637 billion.
Reacting during a bear market can often be detrimental to long-term portfolio growth, especially during periods like the relatively short 17-month bear market from October of 2007 to March of 2009.
If you are still working, a bear market can be an opportunity to buy more stocks at cheaper prices. The best way to invest during bear markets is to put small amounts in every month. You invest a fixed amount, say $1,000, in the stock market every month regardless of how bleak the headlines are. The strategy is called dollar-cost averaging.
Investing every month doesn't work all the time especially if the market is in a long-term uptrend, it is best to have every dime invested as long as possible. But in bear markets regular monthly investing works.
Also investing in stocks that have value and that also pay dividends. Since dividends account for a big part of stock market gains then the bear markets would be shorter and less painful if dividends were included.
It is important to have a financial advisor to “hold your hand” during market downturns. An advisor can help you by preventing you from selling out at the wrong time based on your fear or emotion.
Additionally, having a diversified portfolio in stocks, bonds, cash, and alternative investments is important in a bear market. Alternative investments are non correlated with the stock and bond market so over time having this type of asset allocation has proven to out perform the older more traditional stock, bond and cash portfolio asset allocation model.
Many retail investors will actually stay put because they have been told "you can't time the market." Many will finally say Uncle when they reach their pain threshold. Every bear market is slightly different. In 2008, the place to be was treasury bonds, gold, cash, and shorts using inverse exchange traded funds (ETFs) betting the market will go down.
But if you rely on some type of technical indicators, cash is the most conservative, simply covering up until the dust settles. Investment grade bonds and treasuries historically have been a safe haven. But with interest rates likely on the rise, it won't be so certain this time and the bubble may actually be in bonds. They are currently already off between -5% to -7% depending upon the bond sector. But using short selling ETFs are a simple, elegant way to either make money or simply hedge your long positions you don't want to sell. This can also be owned inside an IRA or retirement account whereas shorting individual stocks cannot. You also don't have to worry about margin interest or margin calls.
I personally will use a combination of cash, short term bonds, and short selling ETFs. I will also consider gold depending upon how it is acting at the time.
Hope this helps. Happy Holidays, Dan Stewart CFA®