Investing basics: how young investors can survive and prosper in a bear market
Don't bother trying to time the market, look out for bargains and above all stay the course - just some of the advice for those navigating their first slump.
Bulls & Bears
If you’ve taken a bet on stocks over the past decade, you know all about bull markets. The term “bull market” describes a condition in financial markets where the value of securities is rising or expected to rise and investors are optimistic. You can think of this as the “good times”.
The latest bull market has been one of the longest on record – running since 2009 and clocking in at 11 years. 2019 was itself a record-breaking year, with the S&P/ASX 200 Index bursting through 7,000 points, and the the index up over 20 per cent.
S&P ASX 200 Bull Market, Growth on $10k
Source: Morningstar Direct
But what goes up must come down. Last week, global stock markets unravelled. Coronavirus panic-selling hit almost every asset class, leaving investors with nowhere to hide. Investors were taken on a wild ride after US President Donald Trump declared a ban on travel from Europe. At close Wednesday, the S&P/ASX 200 Index dipped 3.6 per cent to 5725.9, marking the start of the local bear market.
"There is a sense of fear and panic," said James Tao, an analyst at stockbroker CommSec in Sydney, noting the high-value client desk was swamped with calls.
"It's one of those situations where there is so much uncertainty that no one quite knows how to respond...if it's fight or flight, many people are choosing flight at the moment."
A “bear market” occurs when securities prices fall more than 20 per cent (or more) from recent highs and investors are pessimistic about investing. Over the past 30 years, global markets have slid considerably a handful of times—the 2008 Global Financial Crisis being just one example.
A bear market is often conflated with other terms describing the market or economy faring poorly.
- A recession is generally when gross domestic product declines for two consecutive quarters.
- A pullback is considered a short-term decline in price within a grander scheme of price increase.
- A market crash is a drastic market decline over a few days.
- A depression is a long-term recession that can last multiple years.
'Violent and frightening'
Bear markets are not uncommon and are arguably necessary, even though they can be tough to invest through.
"The first bear market I experienced during my adult life, from 2000-02, seemed particularly violent and frightening," Morningstar director of personal finance Christine Benz says.
"Stocks fell in 2000 and 2001, but the bottom really dropped out in 2002, with the S&P 500 falling 23 per cent. It was no fun to watch my stock-heavy portfolio, which I had presided over with pride during the long bull market, drop more than 30 per cent over that stretch.
"In hindsight, that period seems like a necessary correction, an almost healthy check on the market’s worst excesses of the late 1990s."
Here’s a chart of the S&P 500′s returns in bull and bear markets:
Bull and bear markets through history | S&P 500
If only we knew when those bears would roar, or which investments would survive the mauling. But because each slump brings its own new twists, yesterday's bear-market hero may not survive the next downturn nearly as well.
Benz says lower stock prices can be a positive development for those with a longer time horizon, because the same amount of money buys more securities than when stocks are scaling lofty heights.
As the great value investor Shelby Cullom Davis famously said, "You make most of your money during a bear market; you just don't realise it at the time."
What to do next
Preparing for a bear market is a vexing problem given the variety of bears. So, what should you do now? Younger investors, those in their 20s, 30s and 40s, benefit from having time on their side.
"What's likely to be your main savings goal--retirement--is many years into the future," Benz says.
"Based on the facts alone, market volatility shouldn't ruffle you that much because you have more than enough time for your investments to recover before you begin tapping them during retirement."
But this is easier said than done. Less experienced investors are more likely to get rattled during downturns, Benz says. "Your risk capacity is high, but your risk tolerance may not be."
Benz advises investors to focus their energies on things they can control and tune out what they can't.
"You hold no sway over the direction of the economy or the markets; they're going to do what they're going to do," she says.
"But you do exert at least a modicum of influence over your own situation: how much you save versus spend, how you've allocated your portfolio, whether you've built an adequate cash cushion, and so on."
In these volatile times, Benz advises younger investors to take these five steps:
- Revisit your savings rates
- Review your long-term asset allocation
- Streamline and improve your investment choices
- Assess the adequacy of your safety net
- Make reasonable investments in your human capital
Read Benz's step-by-step guide to taking control: A down-market survival guide for your 20s, 30s, and 40s.
Some other words of wisdom from Morningstar analysts:
Don't try to time the market by switching to cash: All bear markets are marked by false "bottoms"--points at which it appears that stocks won't fall much further but then proceed to fall even more, Benz says. This bear market will be no exception, and what appeared to be a recent trough could be one of several illusory bottoms to come.
Anyone who tries to trick the bear by selling investments and piling up cash will likely suffer less-than-perfect timing and miss out on big stock-market gains. Unless you know something we don't or are extremely lucky, you won't get rich playing the timing game. While the old "buy and hold" mantra may seem like cold comfort at times like this, rest assured that it has a better long-term record than market-timing.
To get some perspective, consider this Index Chart from Vanguard. It charts the growth of market returns since July 1989.
Keep an eye out for quality bargains: Long-term investors can view volatility as their friend. A market downturn can provide investors with a change to increase positions in existing holdings on the cheap, or initiate new positions. Legendary investor Warren Buffett acknowledged the coronavirus will have a near-term impact on companies that he owns, but he also noted that it likely won't make a difference when it comes to their 10- or 20-year outlooks. "If the market gives you an opportunity to buy something you like for far less than it was the day before, you're in luck," he says.
Morningstar analysts expect a large impact in the short term but say valuations on average should be unscathed longer-term. But not every beaten down name will be worth investing in. It’s worth doing your homework before buying in. You can check the 
Morningstar 5-star stock screener (Premium) to see which companies our analysts think are undervalued. Given the current market volatility, the list is changing almost daily.
Safe isn’t necessarily safe: when stocks are down, investors often flee to what's perceived to be the safest of the safe--usually high-quality bonds and defensive stocks, Benz says. "The stampede into safety usually occurs in a bear market's early days; however, and at some point safety becomes, well, overpriced."
Be wary of committing to bear-market funds: An alternative to bond and utilities funds are funds designed specifically to battle the bear, called bear-market funds. These funds typically bet against stocks by shorting stock indices or individual stocks. However, remember that bull markets won't likely be kind to these funds. It's also worth noting that stocks have increased in value over long periods of time, and bear markets tend to be relatively brief in historical terms. Using a bear-market fund effectively requires that you be able to predict when the market is going to head south, and few, if any, investors have shown any ability to do this consistently.
Grin and bear it: Let's face it--investing has its risks, one of which is losing money. It's going to happen from time to time. Diversifying across a variety of fund types and asset classes won't prevent the blow, but it will soften it. Every bear leaves at least a few fund categories with relatively minor injuries.
After setting up a diversified portfolio that meshes with your long-term goals, the best plan is the most obvious one. Stay the course, invest regularly, and promise yourself not to panic when (not if) the market stumbles. The prospect may seem unappealing, but the alternatives can be worse.