We’ve covered bull markets and bear markets before. We’ve talked about the investments that can be utilized to your advantage during each.
Are there certain lessons we can take away from bull markets? From bear markets?
We’ll discuss that and more in the following article.
What can you learn from bull markets?
During a bull market, stock prices go up and to the right. A bull market is an increase of 20% or more. It comes after a recession or a bear market and lasts an average of 4.5 years.
That said, there are certain things you have to keep in mind when it comes to bull markets.
- Past performance won’t predict future returns - Just because you made money last time doesn’t mean it’ll happen again. Each bull market is different than the one before it, so you can’t rely on past numbers when analyzing future investment opportunities.
- Investing in the stock market can increase your wealth - By any historical measure, the stock market might be the best wealth builder. The average return is north of 9%. If your risk tolerance is low, even a little exposure to stocks can help you build wealth over the long-term.
What can you learn from bear markets?
Bear markets are never fun. However, they are almost always short-lived. The average bear market, on the other hand, lasts 1.4 years.
It’s a way of “resetting” the market. During the tail end of an expansion, stocks tend to be overvalued, and investor optimism is responsible for most of the gains at this time.
Here are some key lessons to take away from bear markets.
- Avoid panic selling/fear selling - There will come a point when the market will drop. Your two options are either to trust your plan, stay in, and ride it out, or you read the environment as much as you can and start unloading risky assets. Unfortunately, most people take door number 3. They stay in until they can’t take it anymore, and then end up selling after experiencing the brunt of the losses. If you have a long-term time horizon and can take the pain, stay in. The key is to be allocated appropriately before the pain comes.
- Automate - I specifically want to address periodic contributions. Every two weeks you contribute a percentage of your salary to your workplace retirement plan. This continues during a down market. You are periodically investing at lower prices. This is called dollar-cost averaging, and it lowers your average cost basis, which gives you more room to grow.
- Diversify - Diversification addresses two needs. One, making sure you don’t have too many eggs in one basket. Two, allocating your assets according to your risk tolerance. If you can’t stomach a 30% drop in portfolio value, you might need to invest less in stocks and more in bonds and cash.
- Patience - You need an extraordinary amount of patience when you’re in a bear market. One reason is you have to endure the pain to avoid selling at low prices. You have to trust your plan and hold on. The other reason why is so you can utilize the cash you have on the sidelines. When the economic environment starts to signal recession risks, the best investors will begin to hoard cash. They do this so they can snatch up all the deals when the dust settles.
What can you learn in a consolidation?
When the market stays within a certain range and doesn’t know whether to go up or down, this is called consolidation. You need to do a few things during this time.
- Asset allocation - This is an ideal time to get your asset allocation dialed in. Set an allocation that you feel you’d be comfortable with and back-test it. See how it would do in a strong bull market and in a 2008 type crash. Adjust the allocation as you need to. The key is to set yourself up so you participate in as much of the upside as you can, while also protecting yourself against the downside.
- Unnecessary risk - When nothing is happening, you might get the urge to take unnecessary risks so you can make some money during this period. You need to trust your plan and stay the course. If you take on too much risk and the market dives, you’re going to be kicking yourself.
As amazing of creatures as we humans are, we are not wired to be good investors. Our psyche and our emotions are just too powerful.
Honestly, investing effectively and efficiently is not that difficult. If you invested according to your risk profile and time horizon, set up your periodic contributions, allocated appropriately, and left it alone, you’d probably do extraordinarily well.
Past experiences and behavior will play a huge role in your success as an investor. You have to learn to shut your emotions down (when investing, not in general). If you are comfortable and confident in the plan you set up, then there is no need to make any changes. Especially when the market is down.
Also, do yourself a favor and don’t look at your investments regularly. I wouldn’t look at them any more frequently than once per quarter.
There are a few types of market environments you can experience. Knowing what those environments could bring and how to act during each one will help you succeed as an investor.