Was that a correction or are we headed into a Bear Market?
Over the last few weeks we have seen quite a bit of volatility due to the Fed deciding they are going to start raising interest rates. We saw a dip of just over 10% in the S&P 500 that may have made investors a bit uneasy. With the market still very volatile and investors unsure if the market will continue to go up or down, many are wondering is it over, or will the markets slide farther?
Before we can answer the question of “Correction or Bear Market” we need to know what the difference between the two are. Typically, a “correction” is labeled as anytime the market from its highest high, drops 10% or more. A “Bear Market” is when the index falls 20% or more from its previous peak. How do we know when the market will stop at 10% or when it will fall past 20%?
There is no way of knowing where the market is going.
We don’t, we never know exactly where the market is going. Anyone who tells you otherwise is crazy. A lot of people will use many indicators to figure out where the market has the best chance of going, but, no one is ever 100% sure because the market is somewhat unpredictable.
Wait, you are a financial advisor that is admitting you don’t know where the market is going? Yeah, pretty much. If any advisor told you they knew exactly where the market was going, then I would ask them one simple question…why do they still have a job? Shouldn’t they be off on one of their many yachts or private planes making endless amounts of money for themselves with their crystal ball next to them?
Create a portfolio with downside in mind.
Well, if we don’t know where the market is going and professionals don’t even know where it is going, what do we do about investing? In my opinion, you put a well laid out plan and a quality portfolio in place with the ability to hedge your downside in case of these corrections or bear markets and you don’t panic. If your portfolio is set up to create good returns for you and is hedge to allow for minimal losses in the down years, you stick with it.
“You get recessions, you have stock market declines. If you don't understand that's going to happen, then you're not ready, you won't do well in the markets.” – Peter Lynch
Throughout history, corrections don’t last long and have a short recovery time. The biggest correction from 1965-2014 was in 1980 and from top to bottom was about a 17.07% loss that took 103 days to get back to the peak (if you were invested exactly as the S&P 500). So, if you stayed the course with that correction you were back to where you started in a little over three months, and that was if you were 100% equities with no hedge.
Bear markets on the other hand have a bit more “staying power” unfortunately. Since 1965 the three worst were in 1973, 2000 and 2008 with falls of 48.20%, 48.77% and 56.39% respectably. If you were again in 100% equities with no hedge it would have taken you quite a bit longer to recover. It would have been 2112, 1806 and 1485 days to recover from each of those bear markets. With your retirement in mind, do you really have even 1485 days to get your money back to where it was?
Therefore, minimal downside capture is far more important than upside capture. If you were to limit your loss during any correction or bear market to say, 7%, then you would be able to get back to even very quickly and start making money again. With that said, wouldn’t you rather have a portfolio that will generate 70-80% of the upside in the good years but only 7-8% max loss in the bad periods? Make sure the portfolio you are in will be able to not only achieve high returns, but more importantly won't crumble under the next correction or bear market.
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