Should I Change My Allocation In A Bear Market?

If giving in to emotions can create more harm than good, how should investors react?

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In 2022, equity markets have experienced their fourth Bear market (defined as equity price declines of 20% or more) since the turn of the century. We’ve also seen the Bond market enter a similar Bear market, something that hasn’t happened in nearly thirty years. Bear markets often cause investors to change their portfolios so that they are protected against falling prices. This desire for change in times of difficulty is an emotional response to a current event or circumstance. Unfortunately for investors, emotional responses to current circumstances has usually resulted in a worse outcome than if they’d simply left well enough alone.

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If giving in to emotions can create more harm than good, how should investors react? How can one prepare their portfolio so that they are prepared for a Bear market when it happens?

The first thing that investors should realize is that Bear markets, like Bull markets, are a normal market occurrence. While both stock and bond markets have followed a generally upward trajectory, that upward movement doesn’t happen in a straight line. Prices rise and prices fall constantly.

Second, investors should determine what their investment goals are and over what time frame (time horizon) they expect the goal to be accomplished. For example, if the primary ambition is retirement, investors would calculate (1) the time until retirement and (2) the time spend during retirement in order to determine their time horizon. In general, the longer the time horizon, the less we need to be concerned about market downturns.

Next, investors should determine how much money they will need in order to meet the goal. Then they can determine what kind of return is needed over time, in order to accomplish the goal. From that point, investors can determine an allocation between asset classes (stocks, bonds and cash) that are needed, being very careful to not take any more risk than is necessary to accomplish objectives.

Because the general market trend has been higher and because more risky (i.e., stock) investments have tended to have higher returns over time, investors should periodically review their investments relative to their goals. This will allow them to make modifications and rebalance portfolio allocations to help keep them on the path towards accomplishing their purpose without taking on any undue risks.

Investors need to understand and remember the one truth in investing:  The only way to get higher returns is to take on more risk. However, by taking on no more risk than necessary to accomplish one’s goals, investors will protect themselves against the ravages of performance envy (my friend’s portfolio had better returns than mine) and may protect the long-term value of their portfolio.

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