First, the good news: $1,000 invested in the S&P 500 on the first trading day of 1945 would now be worth over $1,000,000. The bad news? As an investor, you would have had to endure thirteen bear markets, or about one every five years, with each bear averaging a 30% decline (and three surpassing 45%). The chart below illustrates just how common these market declines have been since the end of World War II.
For most individuals, these periods are very difficult. Emotions run high, and the financial media never fail to inundate us with messages of “it’s different this time.” Our brains go into survival mode and we let fear dictate our decisions. The problem with this reaction is that it accomplishes nothing positive and is entirely self-defeating from a financial perspective. Allowing fear to drive decision making is helpful when being chased by a saber-toothed tiger, but not when faced with a bear market.
Many of the so-called “experts” we see on CNBC speak to our fears by suggesting that we get out of the market during rough periods like this. Even though reams of academic research prove it’s a loser’s game, there is still a vocal minority that encourages investors to time the markets. When emotions run high and losses begin to mount, it might feel “safer” to retreat to cash and wait for the markets to rebound, but history hasn’t been kind to those who think they can outsmart the power of an efficient market. Winston Churchill once remarked that “Democracy is the worst form of government, except for all those other forms that have been tried from time to time.” In that spirit, a disciplined buy and hold strategy might feel like the worst form of portfolio management during a bear market, but compared with the alternatives, it provides the investor with the greatest chance at long-term success.
We think there are four important lessons to be mindful of during pronounced market declines:
1) Since the end of World War II, corporate earnings in the United States have grown by 70-fold. The S&P 500 is up 70-fold over that same time frame. If you believe in the power of capitalism and understand that down markets are temporary, you can rise above the short-term noise and focus instead on your long-term objectives.
2) For those still accumulating wealth, bear markets create opportunities to buy assets “on sale.” For those who are no longer accumulating, bear markets create opportunities to realize losses and rebalance the portfolio. Either way, there are opportunities in temporary down markets.
3) A fundamental principle of economics is the relationship between risk and return. Without accepting a higher degree of risk, the investor is foregoing the possibility of a higher return. Bear markets remind us that there are short-term costs (both emotional and financial) to long-term financial gains.
4) Bear markets are a fact of life. If an investor can come to terms with this stark reality, they will no longer be surprised when the next market decline occurs. By removing emotion and using history as our guide, bear markets lose their power over us and we make better decisions.
It bears repeating that $1,000 invested in the S&P 500 in 1945 would now be worth over $1,000,000. This phenomenal growth occurred despite the thirteen bear markets that periodically interrupted the market’s ascent. In summary, we encourage you to remember that bear markets are temporary, but long-term growth in the equity markets is permanent. By remaining disciplined and protecting your projected cash needs, you can both enter and emerge from a bear market with confidence.
