How to Survive Through a Correction or Bear Market

How to Survive Through a Correction or Bear Market

In the last 12 months, the markets have been on a wild ride, with volatile moves to the upside and downsides, culminating in the formation of bear markets in a large number of world financial markets. The financial markets are leading indicators of future economic expectations, and this can lead to increased jitters in expectations of slower economic growth or a recession. Over the last couple of years, we have seen the least amount of volatility in the markets and had been spared from a market correction. While the market corrections can be scary, propagated from red headlines in large text and graphics of roaring bears on financial news networks and news sites, market corrections should be viewed as an opportunity by long-term investors. They are a reminder that it is diversification is essential, corrections are often short-lived and that if you let your emotions cloud your rationale investment decisions, you can be left worse off than if you ride out the volatility.

Focus on your time line and risk tolerance – The financial market is full of different investors with different time lines and different risk tolerance. The best way to ride out a bear market is to try and figure out your willingness, ability and need to take investment risk and what your time horizon is for your investments. If you have a 30-year time horizon, then you should have a different investment strategy than someone with a 1-year time horizon.  It is easy to be an investor when the markets are in a bull market as “all boats float with the rising tide.” A correction or bear market is not a time to be dabbling with investments that you heard from a hot tip or a hunch or a time to try and play in the markets. You can have some “play” money, but you have worked hard to save the funds, shouldn’t you have a thoroughly thought out strategy to set up your investments for your long-term benefit best.

Use the market pullback as an opportunity – As in investor, especially if you are in the accumulation stage of investing, you should be staggering in your funds into high-quality investments using the weakness to build up cornerstone positions of high-quality companies. With having a long time horizon, you can withstand volatility in the financial markets as you are invested for the long run. As such, you should be looking at the correction in the markets as an opportunity to buy high-quality investments and not a moment to panic because of the market volatility. Therefore, when the market goes down 10% you should not be panicking because you’re worried, you should have the mentality of pulling out your buy list and talking to your advisor about making contributions to stagger investments into the market.

This table from Ben Carlson of A Wealth of Common Sense back tests the last market corrections and what has happened to the S&P 500 looking forward one year, three years and five years.
 


Furthermore, looking back at the history of the equity markets since the great depression in 1926, in any given year there is a high chance of an equity market correction. If you extend your period to 10 years, there is over an 85% chance that your portfolio will be better off and if you extend it further to 20 years, there is historically a 100% chance that your portfolio will be higher.

Therefore, if you have a long-term time horizon, it is important to stay invested in the financial markets and should be used as an opportunity to continue to purchase high-quality stocks with slightly higher yields and better prices than were available a few months earlier.

Create a resilient portfolio through diversification  – While bonds are not a sexy investment, they are highly valuable in times of market turmoil as they act as a hedge in your portfolio to stock volatility, provide a consistent cash flow through income and maturities, and can be liquidated (unlike a non-cashable GIC) to be dry powder purchase stocks if the opportunity presents itself. The goal of creating a diversifying your portfolio is to build a portfolio that can handle a variety of market environments that isn’t overexposed to a single risk, taking the pressure off you from having to guess the exact market outcomes in advance (Don’t expect market perfection as it never happens).

The graph below shows market returns of the Canadian Bond and Stock Index, US Stock Index and the EAFE (Europe, Asia and the Far East) Stock Index. Bonds from developed markets are designed to be a counterweight in times on financial market volatility. While having some exposure to bonds may dampen your investment portfolio returns, they also help to reduce the overall volatility in your account and temper your emotions in times of market turmoil; which is essential from causing you to make a poor decision at the worst time.


(Asset Class Returns Since October 1st, 2018: Red-Canadian Bond Universe, Black- S&P 500 in CAD, Green- TSX, and Blue- EAFE CAD Hedged)

Focus on your savings strategy – Just like you cannot out train a poor diet, you cannot out invest a poor contribution plan. Saving and making regular contributions to your investment accounts is the most important thing you can do in your 20s and 30s and that while what investments you choose can make a significant difference, the effect of creating good habits has a significantly more substantial impact. Compound investment growth takes times and in illustrated in the graph below, if you were to earn a compound rate of return of 5.5% a year and make contributions of $6,000 a year into a TFSA, it would take 24 years for your amount of investment growth to equal the contributions you have made to the account.


 
Remember that market corrections and bear markets are normal - Since 1945, the S&P 500 has experienced a double-digit correction roughly once every other year and a bear market once every 5 or 6 years. Volatility is a common occurrence in stock markets and the unimpeded bull market over the last ten years (especially in the previous three years) has been an exception to the rule, not the norm. In the long run, equities outperform other asset classes, but this is not meaning that in any given year the stock market will not experience volatility. It is important to remember that investing is difficult and that even the best-laid investment strategies can be wrong. Your best strategy if you long-term investor is to continue to accumulate high-quality stocks when they go on sale, don’t time the markets and have a strategy and asset allocation that allows you to stay invested for the long term.

Corrections and Bear Markets are a natural occurrence in financial markets and can be an opportunity for investors to accumulate high-quality stocks at a discount that can become cornerstones of your portfolio for the next few years. While it can be extremely stressful time to check the financial news or your statements, it is essential to try and focus on your time horizon and not get dragged into short-term thinking that could de-rail your portfolio. It is important to focus on process-oriented goals such as continuing savings strategies and staggering the timing of your investment that when repeated create long-term value.


If you liked this article, sign up for our newsletter.