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The Fifth Philosophy: How to Slay a Bear Market

By Jimmy Turner, MD
The Physician Philosopher

[If you haven’t checked out the new Student Loan Refinance Page, go check it out.  I have spent hours of work on it and loaded it with information and good deals]. In 2008, most people lost a substantial portion of their retirement portfolio.  Depending on how aggressive your portfolio was, you may have seen your investments cut in half or possibly even more.  In one terrible week in October of 2008, the Dow Jones fell 18% in one week.  [And we thought last week’s -2% downward movement made for news!  Man, we’ve been spoiled by the recent bull market]. Could you stomach watching $500,000 turn into $250,000 over the course of months, or lose $100,000 in one week?  A Bear Market is not the time to find out who you are in terms of your ability to withstand corrections and recessions.  You need to have a fortified understanding of the market and have a plan  to slay the bear market before it comes! Welcome the Fifth Philosophy of a Moderately Frugal Life.

Know Thy Enemy

The phrase “know thy enemy” comes from a translation of Sun Tzu’s Art of War where he says the following:
It is said that if you know your enemies and know yourself, you will not be imperiled in a hundred battles; if you do not know your enemies but do know yourself, you will win one and lose one; if you do not know your enemies nor yourself, you will be imperiled in every single battle. ~ Sun Tzu
The Art of WarIn essence, Sun Tzu is pointing out that if you don’t know your enemy you will have a 50/50 chance of winning the battle depending on whether you know yourself.  If you don’t know yourself at all, you will lose every single battle.  Know both yourself and your enemy and you will withstand 100 attacks! Bear markets are not the enemy.  Similar to Sun Tzu’s quote above, you must realize that the enemy in a bear market is yourself.  Therefore, you need to know yourself and know yourself well in order to be successful in a Bear market.  Otherwise you can expect to lose the battle before it has even begun.

Why Am I the Enemy?

As Jonathan Clement explains in his book How to Think About Money (I highly recommend this book!), he often gives a multiple choice question to his college students taking personal finance.  Directly from Clements:
“Imagine you are in your 20’s and saving every month for retirement.  What pattern of market performance would help you accumulate the greatest wealth, assuming stocks had the same cumulative gain over the period? A. High returns now, low returns later B.  Low returns now, high returns later C.  The same return every year”
He points out that most people get this question wrong and assume the correct answer choice is C.  However, the reality is that as you pump money into the market at the beginning of your career you are hoping for choice B so that you can buy stocks at a relative discount to their true value.  This is exactly what occurs during a Bear Market as stocks dip in value and, if you continue to invest, you actually get to buy these same stocks at a discounted price that (if history has anything to say) will eventually rebound to put you ahead. I hear you asking, “what if it doesn’t rebound.”  Well if it doesn’t rebound you didn’t need to stop investing and sell your stocks.  You needed to buy non-perishable canned foods, water, guns, and ammunition.  That’s your only real protection to a true market (and economic) crash. Assuming the market doesn’t completely crash it is normal to expect corrections (and even recessions).  The market will always rebound though as the innovation of humankind trumps fear.

The Fifth Philosophy: Slaying the Bear Market

Clements talks about how to slay the Bear. Great “perspective book” on money.

The real philosophy to be taught here is to know yourself.  Your long term money should be in stocks.  If you don’t need it in the next 5 to 10 years, you should be investing heavily in low cost index mutual funds.  However, if you are nearing the point where you will need to draw from your accounts, then you should (of course) have more money in short-term bonds.  A recession close to retirement can be brutal without an adequate asset allocation and mixture of funds. However, if you are more than 5 years from retirement, you should know thy enemy.  Thy real enemy is you.  If you cannot stomach seeing such wild losses and continue to invest, you need to find the balance of Stocks/Bonds that works for you. For example, assuming you have 10-20 years or so til retirement, if you go through your first correction (decline of at least 10% in value) with an 80% stock/20% bond mix and find that it was un-bear-able (that was punny!), then transition more of your funds into bonds.  Maybe a 70/30 mix would be better for you.  If, however, you went through your first significant correction without even noticing it, maybe you ought to be 90/10. The worst thing that you can do in a Bear Market is to sell low and buy high.  You cannot time the market and, in fact, this has been shown to be the likely cause of poor financial performance during recent recessions.

So, here it is The Fifth Philosophy: How to Slay the Bear Market (Take care of the Head and the Heart)

1) Stay the moderately frugal course. Follow your head.  You know that the market always rebounds. [If it doesn’t, like Japan in the 1990s, then we are all in trouble and your decision likely didnt matter].  If you can deal with your worst enemy (you making major changes in a down market), you will reap the rewards later.  After all, if the market tanks and doesn’t recover your retirement portfolio is not the only thing in trouble.  We all are. [A funny story I once heard involved someone’s best advice during a Bear Market involving logging into your financial accounts and letting your best friend/spouse change the password so that you no longer have access til the market recovers.  This is a much better alternative than selling low and buying high].

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2) Don’t forget the heart! Have a good mixture of stocks/bonds that allow you to tolerate the volatility of the market.  If a correction gives you a panic attack, increase the percentage of bonds in your portfolio.  If you didn’t even notice, you may be able to stand being more aggressive. Find the number that works for you.

As always, the key to achieving a moderately frugal life is to make both the head and the heart happy!  You can do this even in the midst of a Bear market.  First you must, know thy enemy.

What do you think?  Have you made mistakes in prior Bear Markets?  How do you recommend someone slay the Bear?  Leave a comment!

TPP  

12 Comments

  1. Doc G

    Know yourself and what can you stomache! Better yet, stop checking the market and just keep investing!

    Reply
    • ThePhysicianPhilosopher

      All of the above! Have to know what to do before it happens and expect it to happen. Thanks for stopping by!

      Reply
  2. FullTimeFinance

    Our asset allocation is set based on what I know as my risk tolerance. That’s the best preparation I can do beyond staying the course.

    Reply
    • ThePhysicianPhilosopher

      Seems like you know thyself well, then! That’s a recipe for success. Staying the course is far and away the most important part. Knowing how much risk you can tolerate will help determine whether you’ll actually stay the course or not.

      Reply
  3. Millionaire Doc

    I’ve been through several bear markets, but today was still painful. Stay the course, buy into weakness.

    Reply
    • ThePhysicianPhilosopher

      Being young in my career, I am perfectly good with a correction or bear market.

      I really like that phrase though “Buy into weakness!” I might use that one

      Reply
  4. Evan @ MyJourneytoMillions

    According to a study by JP Morgan, the average return for the retail investor is under 3%. It isn’t because of fees (although those hurt like hell) it has to do with just investors failing to get out of their own way (http://www.myjourneytomillions.com/articles/amazing-statistics-jp-morgan-market-insights/). Really if you are young (36 here) these are fantastic! I started my 401k way late but it was almost exactly in 2007! I got that backwind for the past 10 years

    Reply
    • ThePhysicianPhilosopher

      Really interesting stats. It is true that if you just set it and forget it (hopefully into low cost index funds) you are almost certainly better off.

      I really do like the graphs. And based on the conversations I have at work daily with different people it is not surprising to me that the average investor makes less than 3%.

      2007 would have been a great time to start, too! You were a part of what physician on fire calls the Nike swoosh stage (down for a bit then up and to the right since then)

      Reply
  5. Gasem

    Notes from underground:

    Consider learning something about the Efficient Frontier. Portfolios are predictable in that they have both risk and reward. Choosing percentages really has nothing to do with what you can “stomach”. It has to do with what is most efficient ratio of non-correlated asset classes across decades, and that number can be calculated not guesstimated.

    The point of non-correlated assets is if one class goes bear typically other assets act as ballast buoying up the portfolio until the bear retreats. By owning non-correlated assets you can often dramatically reduce volatility (risk) without much hit on reward. In 2007 the market crashed and I had moved my portfolio into a risk adjusted asset mix. My portfolio fell by about 35% where as a SPY portfolio fell closer to 50%. My portfolio reached parity in 2011 where as the SPY portfolio wasn’t even till 2013. By 2013 I was 18% ahead. If you loose 50% you need to make 100% to get even. If you loose 35%, 70% gain does the trick.

    Here is a calculator so you can play with asset correlation and efficiency

    https://www.portfoliovisualizer.com/efficient-frontier

    and here is a primer on efficient frontier

    https://www.investopedia.com/terms/e/efficientfrontier.asp

    If you look at the drop down under the gear symbol there are several “portfolios” like the bogelhead 3 you can test. You will be amazed at how inefficient those portfolios are because of too much risk. If I had understood efficient frontier when I was at your stage of my career I would be twice as wealthy as I am today.

    Reply
    • ThePhysicianPhilosopher

      Thanks for the comment, Gasem!

      That’s not something I am terribly familiar with. Appreciate the links! I’ll read up on it to see what it’s all about!

      Reply
  6. Financialpilgrimage

    I have to continually remind myself that I plan to be in the market for 20+ years. Lower stock prices is actually a good thing since I can get more shares at a cheaper price. This assumes, of course, that the market will rebound.

    Reply
    • ThePhysicianPhilosopher

      It’ll rebound. And if it doesn’t, you didn’t need more bonds in your portfolio… You needed an AK47, ammunition, lots of water, and canned food.

      Reply

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