The key to building wealth during today’s bull markets, bear markets, and corrections.
You have heard—those who refuse to learn history, are doomed to repeat it. This statement is relevant in many areas, and investing and wealth management are not excluded. It is important to know at least a passing history concerning the securities markets because knowing the history will help you avoid some of the past mistakes investors have made—sometimes over and over. A passing knowledge also demonstrates why the tortoise approach of slow and steady saving and investing works—while the rabbit approach of market timing and seeking home run investments is a recipe for disaster.
It is extremely important to understand that markets go up, but they also go down. You may understand that in theory, but in reality, when markets go down, some investors lose their focus.
“Should I go to cash?”
“Should I get out now and come back when things start to turn?”
“Should I sell low now and buy back in high?”
Nobody ever really asks that last question, but that may be the effect on their wealth if they follow the instincts indicated by the first two.
Understanding the history and terminology of the markets will help you navigate the playing field and avoid repeating past mistakes. It is smart to learn from your own mistakes—but it is wise to learn from the mistakes of others—and not to mention, much less painful.
Bull markets (Up Markets)
Many technically define a bull market as period of increase in value in the market of at least 20 percent. But there is more to it than that. Bull markets are characterized by optimism, investor confidence, and expectations that strong results will continue. It’s difficult to predict consistently when the trends in the market will change. Part of the difficulty is that psychological effects and speculation may sometimes play a large role in the markets.
Bear Markets (Down Markets)
Bear markets represent a market condition in which the prices of securities are falling, and widespread pessimism causes the negative sentiment to be self-sustaining. As investors anticipate losses in a bear market and selling continues, pessimism only grows. Although figures can vary, for many, a downturn of 20 percent or more in multiple broad market indexes, such as the Dow Jones Industrial Average (DJIA) or Standard & Poor’s 500 Index (S&P 500), over at least a two-month period, is considered an entry into a bear market.
A market correction is a reverse movement, usually negative, of at least 10 percent in a stock, bond, commodity, or index to adjust for an overvaluation. Corrections are generally temporary price declines interrupting an uptrend in the market or an asset. A correction has a shorter duration than a bear market or a recession, but it can be a precursor to either.
Making Strategic—Not Emotional—Investment Decisions
Those textbook definitions help us understand the technical side of market movements, but do little to address the psychological effects on investors. How emotion plays a major part in your investment decisions.
When talking with clients about market volatility, we often discuss emotion. Money, and specifically your money, is very personal and emotional to you. During bull markets and investor enthusiasm, emotion can often cause irrational decisions such as buying more of a particular security—not because the fundamentals suggest there is value, but simply because you have possibly felt short-term exuberance from gains and more of that feeling would seem logical. The problem is emotion can often negatively affect your portfolio strategy. While it is present in bull markets, we most often see the biggest problems arising during bear markets. Down markets force people to assess the damage in their portfolios more often, which leads to pain from seeing losses, which leads to even more monitoring of performance. It becomes a vicious cycle.
The natural instincts of investors are often wrong. Buy low and sell high often requires you to do the opposite of your instincts.
In today’s world, we are besieged with news and information at our fingertips. Investment advice and thoughts are now being blasted out to the masses in 140 characters or less. When markets are stable and calm or rising during a bull market period we see less breaking news and instant analysis. It is precisely at the time investors need guidance—during corrections and/or bear markets—that we have news headlines such as “plunging equities”, “another crash is on the way”, “death spiral for the markets”, and so on.
Investors, who we have said are already emotionally tied to their hard-earned money (as they should be), are now being preyed upon from multiple media. This makes it very difficult to make sound financial decisions.
When clients contact us to ask if they should change their strategy, we respond with one simple question. Has anything changed in your life since our last meeting that would alter your goals or change your tolerance for risk?
If the answer is yes, we will discuss how their investment portfolio is currently constructed—what type of return is expected as well as the type of volatility. If those factors are no longer aligned, we will make the necessary changes. Usually, the answer is no. “I’d still like to retire on X with X amount of money to last X amount of years and I am comfortable with losses of X.” If those goals match their current portfolio, we will discuss the emotion of the markets and how best to take advantage of the environment.
In our opinion, the best way to navigate unpredictable elements is to chart a course and stick to it, but remain flexible to avoid getting trapped. You must adjust at times—but adjust strategically, rather than emotionally.
Experience makes experts of us all—but you can’t get experience overnight. However, if you understand the history of the securities markets, you gain experience a little quicker and much less painlessly. Be smart and learn from your mistakes—but also be wise and learn from the mistakes of others.
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Robert Peelman, CFP, is a contributing author of Wealth Management Made Simple and the Director of Wealth Advisors at the wealth management firm OJM Group www.ojmgroup.com, He can be reached at 877-656-4362 or firstname.lastname@example.org .
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This article contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized legal or tax advice. There is no guarantee that the views and opinions expressed in this article will be appropriate for your particular circumstances. Tax law changes frequently, accordingly information presented herein is subject to change without notice. You should seek professional tax and legal advice before implementing any strategy discussed herein.