A Bear market is a period where equity markets fall – an inescapable feature of equity investing. They are also the greatest challenge that investors will face.
This is not because of the (hopefully temporary) losses that will be suffered, but the poor choices we are liable to make during them. Bear markets change the decision-making dynamic entirely. In a bear market, smart long-term decisions often look foolish in the short-term; whereas in a bull market foolish long-term decisions often look smart in the short-term.
When investing there are some important points to remember when experiencing a bear market. We have summarised some key considerations below.
They are inevitable
Bear markets are an ingrained aspect of equity investing. We know that they will happen; we just cannot know when or why. That they occur should not be a surprise. The long-run return from owning equities would be significantly lower if it were not for bear markets.
It will feel predictable
As share prices fall, hindsight bias will run amok. It will seem obvious that this environment was coming – the warning signs were everywhere. We will blithely ignore all the other periods where red flags were abundant and no such market decline occurred.
We won’t call the bottom
Market timing is impossible, and this fact does not change during a bear market. The only difference is the attraction of attempting it when portfolio values are falling can become overwhelming, and the damage it inflicts will likely be greater than usual.
Our time horizons will contract
Bear markets induce panic, which means our time horizons shorten dramatically. We stop worrying about the value of our portfolio in thirty years and start thinking about the next thirty minutes. Being a long-term investor gets even more difficult during a bear market.
We won’t consider what a bear market really means
In the near-term, bear markets are about painful and worry-inducing portfolio losses, but what they really are is a repricing of the long-run cash flows generated by a business / the market. The underlying value of those businesses doesn’t change anywhere near as much as short-term market pricing does.
Our risk tolerance will be examined
Bear markets are the worst possible time to find out about our tolerance for risk. Everyone becomes risk averse when they are losing money. The problem for investors is that living through a 37% loss is a far different proposition to seeing it presented as a hypothetical scenario. If possible, we should avoid reassessing our appetite for risk during tough periods.
We will extrapolate
During a bear market, it is hard to see anything ahead but unremitting negativity. Our tendency will be to believe that things will keep getting worse – prices will be lower again tomorrow.
Each bear market will be different
We should ignore all charts comparing current declines with other bear markets in history, they are entirely unhelpful. There is no reason to believe that such a deeply complex, unpredictable system should mimic patterns of the past. Each bear market is unhappy in its own way.
Bear markets are the ultimate behavioural test
The outcomes of bear markets are more about us than they are about the market. Investors entering a bear market with identical portfolios will have wildly different results based on the decisions that they make during it.
Equity bear markets make all the usual challenges of being a long-term investor that much more difficult. The noise of daily market fluctuations will become deafening, we will check our portfolios even more frequently and may find the urge to make short-term trades irresistible.
Simon Dawes, Head of Wealth Management at Cooper Associates Wealth Management, said:
“In times of a bear market, the rationale investor will always succeed over an emotional investor. It is too easy to make knee-jerk reactions which can severely impact your long term financial goals. During these periods, it has never been more important to make sure that you receive quality financial advice that will help you to navigate these seemingly turbulent times and ensure your plan is on track to achieve your financial goals.”