Know Thy EnemyThe 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 TzuIn 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 MarketThe 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].
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