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Bear Market or Correction…and How to Protect Your Long-term Investments
The markets can feel like a seemingly never-ending roller coaster, where the climbs are steady, but the drops are sudden and steep. That drop? It’s likely a bear market, a term that gives even the most seasoned investors the chills. A bear market is usually defined as a decline of at least 20% from recent highs in major stock indexes like the S&P 500. Unlike a correction, a bear market doesn’t just nibble at your portfolio; it claws at it.
Bear markets are often associated with prolonged economic downturns or recessions. They are triggered by negative investor sentiment, economic slowdowns, and fears of future declines in returns on investment. The average bear market lasts about nine and a half months, although the one in 2020, fuelled by the COVID-19 pandemic, lasted only a month.
During a bear market, it can feel like the sky is falling, and the urge to sell everything is strong. But here’s the thing: historically, these periods of decline have been shorter than the periods of growth. The key is to stay calm and stick to your long-term investment plan.
What Causes Bear Markets?
Bear markets often arise when investors anticipate a weak or slowing economy. These perceptions, whether justified or not, can cause widespread panic. Events like geopolitical tensions, inflation spikes, or unexpected political decisions can also serve as triggers.
How to Survive a Bear Market
So, how do you survive a bear market? By staying invested and keeping your eyes on the long term. Historical data shows that markets tend to recover, and those who hold onto their investments generally fare better than those who sell in a panic.
One study found that missing just a few of the best days in the market because of panic selling can dramatically decrease your returns over time. Historically, the best days in the market tend to happen very closely after the worst days – i.e. just as many investors fought the urge to encash their portfolios during downturns is the exact time when they should have been seeking to take advantage of the downturn by investing more! As legendary investor Warren Buffett famously said, “The stock market is designed to transfer money from the Active to the Patient”.
The Correction: A Temporary Setback
Corrections, on the other hand, are like those times when your car hits a pothole and jostles you awake. Annoying? Yes. Permanent? No. A correction is a market decline greater than 10% but less than 20%. Unlike bear markets, corrections are typically short-lived, lasting on average three to four months.
Corrections can again occur due to short-term factors like sudden geopolitical events, economic reports that miss expectations, or even changes in investor sentiment. They often serve to “correct” prices, bringing them back in line with a long-term trend.
How to Benefit from a Market Correction
Corrections, while uncomfortable, can present excellent buying opportunities. For long-term investors, a market correction can be the perfect time to buy high-quality stocks at a discount. As stock prices drop, investors can purchase shares that will likely appreciate over time.
For those with a diversified portfolio, a correction can also be an opportunity to rebalance. Rebalancing helps ensure your portfolio remains aligned with your investment goals and risk tolerance.
The Long-Term Investor’s Best Defence: Diversification
If there’s one lesson that both bear markets and corrections teach us, it’s the value of diversification. Diversification means spreading your investments across various asset classes, sectors, and geographical regions to reduce risk. By doing this, you’re not overly reliant on any single stock (think bank shares!), which can help smooth out the ups and downs of the market.
Why Diversification Works
Diversification is crucial because it allows you to capture the gains from different areas of the market while reducing the risk that comes from being too concentrated in one area. As one sector declines, another may rise, helping to offset losses.
Asset Allocation: The Heart of Diversification
Asset allocation refers to how your investments are divided among different asset classes, such as stocks, bonds, and cash. A well-diversified portfolio often includes a mix of these assets, tailored to your financial goals, risk tolerance, and investment horizon.
The idea is simple: don’t put all your eggs in one basket. By spreading your investments across different asset classes, you can reduce the overall risk in your portfolio and potentially increase your returns over the long term.
Long-Term Investing: Staying the Course
So, what should you do when the market turns turbulent? Keep calm and stick to your investment plan. The most successful investors understand that the market’s short-term swings are just noise. They focus on the big picture and the long-term growth of their investments.
Time in the Market Beats Timing the Market
Trying to time the market is a fool’s game. Even professional investors find it nearly impossible to predict market movements consistently. Instead, focus on time in the market. Studies have shown that staying invested over the long term is one of the best ways to build wealth.
Conclusion
While bear markets and corrections can be unsettling, they are natural parts of the investing journey. Understanding the difference between the two and knowing how to protect your investments can help you weather the storm.
Remember, investing is a marathon, not a sprint. By staying diversified, keeping your eyes on the long term, and resisting the urge to make rash decisions, you can navigate the ups and downs of the market with confidence.
In Their Own Words