Bear market: Don't get spooked

Human beings tend to get emotional in a down market. But those that can endure the pain, will reap the benefits.

By The Mole, Money Magazine's undercover financial planner

NEW YORK (Money) -- Question: I'm seeing my account values take a daily dive and I've lost all of my gains from the past year, and then some. I'm hearing recession predictions and I'm wondering if I should cut my losses and get out of the market now. Do you think this is the beginning of a bear market?

The Mole's Answer: Don't panic! The bad news is I have absolutely no idea what the market will do in the short-term, nor does anyone else. The good news is that I'm 100 percent confident that:

  • The market is a great long-term investment.
  • The ups and downs of the market impact our financial futures a whole lot less than our reactions to it.

Unfortunately, we seem unalterably programmed to buy high and sell low. And even though history shows us time and again the error of this, we keep doing the same thing and expecting a different result.

The market is now down about 10 percent for the year and more than 15 percent from its high in October of last year. Sensationalistic headlines read something like "worst start ever for the stock market," and "as January goes, so goes the year." Such anxiety-inducing hype makes it virtually impossible for us to ignore the doom and gloom and just stay the course, but that's exactly what you should do.

Behaving badly

The current crisis du jour in the market, like almost all of them, has its roots in how we invest. It was incredibly easy three months ago to say that we have a high tolerance for risk. We had just seen our U.S. stock portfolio nearly double and our international stock portfolio nearly triple. With such a whopping gain, one would think we would surely be able to handle a small 15 percent pullback, right?

The truth is that most of us are fair weather investors. Our tendency to be risk tolerant in good times, and risk averse in bad times, causes us to feel a bit bullet-proof. The result is getting into stocks when the market is up, and doing the traditional "panic and sell" when it turns downward.

It may be hard for many of us to remember back to October of 2002 when stocks bottomed out, having fallen by nearly half since 2000. To jog your memory, go back to an article written by Jason Zweig, at the bottom of the bear market: Are you wired for wealth? Jason gave us a glimpse into our minds and explained why most of us were panicking and selling at the exact wrong time.

How to be an investor

It's easy to consider yourself an investor in good times, but it's the down markets that separate the real investors from the speculators. An investor understands that, after five straight up years in the market, a pullback is just part of the game. It's okay to feel the pain as long as you don't let it drive you to panic. As much as I hate to admit it, I look at my own portfolio daily for some reason I'll never be able to explain. I feel your pain, but I know my instinct to sell is dead wrong.

An investor needs to understand and have faith in the fact that capitalism works. Not to mention the fact that in the history of the U.S. stock market, it has only lost value a couple of times over a ten year period. Because rebalancing is a critical part of one's investing, now is the time to reallocate more toward equities, as long as one had a proper asset allocation strategy in the first place. After all, it's better to buy things on sale, isn't it?

My Advice: If you can't sleep at night wondering how much more stocks will fall, then the stock market was never right for you in the first place. Moving in and out of the market is likely to give you a low return.

On the other hand, if you can accept that bear markets are a necessary part of stock market investing, then look at this as a buying opportunity. If the market goes down further, it's an even better buying opportunity.

In the words of Warren Buffett, "Be fearful when others are greedy and greedy when others are fearful." That may be easier said than done, but it's good advice.


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