Practical investment tips for a challenging market
It’s been a tough year, both financially and otherwise. Rapidly rising interest rates. Sky-high inflation. Most world economies teetering on the brink of recession. War in Ukraine. The looming spectre of a rerun of the coronavirus nightmare. Needless to say, all the bad news has added up to a significant bear market – one that has mauled pretty much every investor.
By the time you read this, of course, the bear market may be over and the stock market may be well on its way to a recovery. Or, perhaps, a new economic or political event will send world economies tumbling over the edge into deep recession. Or maybe neither of these will happen, and the stock market will keep chugging along without a strong sense of direction for several more months.
But it almost doesn’t matter. If you’ve lived through the dramatic dips and dives, the head-fakes and false starts, the rapid rises that only turn out to be the start of another leg down, you might be wondering: what the heck should I do now? What moves should I make to protect my family’s wealth? What investments should I avoid? What strategies should I put into place? And perhaps, the biggest question of all: how exactly can I use these wild ups and downs to my advantage?
All great questions. And, while no one can say for sure how long the market malaise will last (or when another bout will hit us), there are most definitely practical steps which you can take to help “tame” the current bear market – or any other bear market that you might encounter during your investment lifetime. Taken together, the tips below should help position you for what comes next in the stock market, help you better navigate future volatility and ensure that bear markets don’t take a big bite out of your nest egg.
Get your financial house in order
The first step to surviving and thriving in any bear market is to have a clean “financial house.” Taking care of the foundations of personal finance is good advice in any economic environment, but it’s doubly good advice in difficult times such as bear markets. If any of the following topics require your attention, it’s probably best to focus on these before you turn your mind to the stock market:
Get rid of high-interest debt – still paying down your credit cards? Have a balance on your home equity line of credit? Haven’t paid off the car yet? Getting those things paid off (or at least well under control) should be your number-one financial priority in bear markets, bull markets or anything in-between.
Control the mortgage – can you pay off the mortgage? Great – do it. If you’re still working on it, make sure that what remains is down to a reasonable size, so that if interest rates go up by a few more percentage points (as they may well do), you won’t lose any sleep.
Emergency fund – do you have a “just in case” stash of easily accessible cash? If not, make it a priority to build one. The exact size of such a stash will vary according to your comfort level, but everyone should aim to have at least enough to deal with a roof that starts leaking, a car transmission that starts making funny noises or a washing machine that goes to the great appliance centre in the sky.
“Bucket list” spending – got a grandkid who needs help with tuition? Planning a once-in-a-lifetime African safari? Have your eye on your dream car or dream cottage? Determine a price tag for these items and put the money aside in an ultra-secure savings account, GIC or similar investment – you don’t want a stock market downturn to stop you from crossing items off of life’s to-do list.
Insurance – have you protected your assets (home insurance), your health (critical illness insurance) and your earnings power (life insurance)? If you’re fortunate enough to have a substantial portfolio, a house that’s paid off and very little debt, perhaps you don’t need such protection. But if you do, make sure that it’s in place before you go shopping for bear market opportunities.
Estate plan – is your will up to date? Does it fairly reflect your current life situation regarding spouses, life partners, children, grandchildren and other friends and family? If not, seek out a legal professional (no, a do-it-yourself will kit doesn’t count) and get it done.
None of these to-dos could ever be considered groundbreaking financial advice. And they’re certainly not the things that give you “bragging rights” at a cocktail party. But taking care of them remains the most significant, most important step which you can take during challenging times – easy, practical steps that can make a dramatic, lasting impact on your financial future… no matter what the market may be doing.
Ditch the “timing the bottom” mentality
During a bear market, a lot of individual investors define success as timing the bottom: waiting for the exact moment at which the bear market reaches its nadir, and then going “all in” when they can pick up stocks, bonds and other investments at ultra-low prices. And we agree that such a strategy can be an excellent way to make money – IF you can manage to find a way to predict exactly when the bottom will happen (if you do, make sure to tell us and we can all get rich together!).
Perhaps you’ve heard the saying: “perfect is the enemy of great.” It’s a good thought to keep in mind in bear markets. Many times, investors who keep on waiting for the “perfect” time to invest suffer from a strange kind of paralysis, missing out on the explosive gains that can often happen when markets snap back unexpectedly. Or, to put it another way, by obsessing about perfect timing, investors miss out on great opportunities.
Interestingly, professional investors and portfolio managers rarely concern themselves with getting their timing absolutely right during a bear market. Sure, they pay attention to economic trends and market movements, and hold off on making big bets in times of extreme volatility. But, with the exception of high-flying momentum traders, most professionals are content to get their timing broadly right. By refusing to worry about timing, they have more “mental space” in which to pay attention to issues and topics that are ultimately much more important when it comes to determining long-term investment success: the underlying thesis of their investment ideas, for example, or the business fundamentals of the companies which they’re interested in.
Shifting your thinking about timing leads naturally to a very simple, very practical strategy for bear market investing: dollar-cost averaging. Instead of waiting to go all in when the timing is perfect, you make purchases in tranches and build up your position over time. No, it’s not a new strategy. Nor is it especially complicated or difficult to implement. But it’s the one approach that nearly every successful investor (professional and amateur alike) has used to build wealth in challenging times.
Investing in stocks? Focus on the business, not the market
Part of what makes equity investing so challenging is that every stock is a combination of a business and a financial instrument. On one level, every stock represents an ownership share in an underlying business; the value of that ownership share will fluctuate over time with the successes (and sometimes failures) of that underlying business. But every stock is also a financial instrument that will fluctuate over time with the (often irrational) emotions, perceptions and beliefs of millions of other investors, analysts, pundits and commentators out there in market-land.
Veteran investors, who have a good sense of when the emotions and opinions of the broad investment public become divorced from the logic of a given business, can use these emotional reactions to pick up exceptional businesses at exceptional prices. But in a bear market, it’s usually a lot easier (and a lot safer) to simply filter out this emotional “noise” and keep laser-focused on the underlying business data of a given stock. By doing so, you keep your attention on information that is known, measurable and somewhat predictable (business earnings), rather than worrying about what remains unpredictable, capricious, and largely outside of your control (market sentiment).
So, if you’re interested in investing in stocks during the bear market, start by asking yourself some fundamental business questions: how is the company doing in a challenging economy? How much debt does it have – is it vulnerable if interest rates rise? How much cash is coming through the door, and will that cash continue to come through the door during a recession? Once again, none of these questions is groundbreakingly new, nor do they require a PhD in finance to understand. But they remain the foundation of most successful investing, particularly during times of market turmoil.
Look for opportunities beyond the recent past
If you’re a student of stock market history, you’re probably well aware that one of the near-certainties of any bear market is that the high-flying stocks of the recent past come back down to Earth. Understandably, some investors view that as an outstanding opportunity to pick up shares on the cheap before those former market darlings return to their highs.
It’s a good idea in theory, but a little more dangerous in practice. The fact is, the companies and investment strategies that did well during long bull markets are rarely the ones that continue to work well after the bear market rears its head. And it’s not really a big mystery as to why: the positive economic and business circumstances that often lead to outperformance during bull markets are usually the ones that change dramatically in bear markets. This dramatic change naturally leads to a re-evaluation of investor opinion, which can often lead to a stretch of underperformance, both during bear markets and in the years immediately following.
We can see recent examples of this phenomenon in the so-called FAANG stocks (Facebook, Amazon, Apple, Netflix, Google) of today. Leading up to 2022, all of these stocks performed spectacularly well, but they’ve suffered since the start of the year. Meanwhile, sectors that were formerly out of favour (energy, for example) have been among the strongest recent performers. Meanwhile, fixed-income assets such as government bonds, GICs and similar investments that have been pooh-poohed for years are looking increasingly attractive as interest rates rise.
Will the FAANGs and similar stocks that performed well during the last bull run reach their former highs again? They absolutely might – many of them remain excellent businesses with a long runway for future growth. But they’re not nearly the “slam dunk” that you might think, if all you’re paying attention to is how far they’ve fallen. If you’re an investor who enjoys doing research, has a strong stomach for volatility and has a whole lot of patience, then sure, you might find yourself some great bargains by taking a look at former market darlings. For the rest of us, however, it’s best to widen our search for opportunities beyond the recent past, and keep an eye out for businesses better situated to succeed in the new economic environment, rather than the one we just exited.
Focus on long-term quality instead of short-term speculations
During times of easy money when credit is cheap, the economy is expanding and venture capitalists are willing to throw money at a variety of high-risk, high-return startup businesses, investors with a strong stomach for risk can often find intriguing speculations that can pay off big-time. During a bear market, however, things change. The economic environment in which such speculations flourish can evaporate quickly. High-flying hedge funds and angel investors aren’t so quick to support crazy business ideas. And the increased sensitivity to risk that often accompanies a bear market can make it much more difficult for “hot stocks” to pay off.
There’s a time for taking a flyer on a promising idea, and a time to stick to quality businesses. A bear market firmly belongs to the latter category. Unless you’re an active trader or an experienced investor with a penchant for risk, it’s probably best to view the bear market as an opportunity to build a long-term portfolio of quality businesses rather than a treasure hunt for short-term speculations that can make you a quick buck.
Instead of focusing on hot stocks, identify businesses with a long-term competitive advantage –businesses that you’d be happy to hold for five, 10, 20 or even longer. Seek out companies that will survive and thrive no matter what the economic conditions. Build a foundation of investment income that will see you through your golden years. Identify opportunities in quality businesses that will grow over time, rather than risking it all on a crazy idea that may pay off, or may end up costing you everything.
Above all, remember this: if you’re tempted to speculate, do so rationally. Make sure to do your research. Keep the total amount which you invest in such opportunities small. Have a sell target in mind, and establish a limit to the losses which you’re willing to accept if the idea just doesn’t work out.
Use the bear market to build income
A bear market can be an excellent time to build the income side of your portfolio. By buying income-generating assets now – when prices are considerably lower (and yields considerably higher) – you create a solid foundation of steady income that can hold you in good stead throughout the future.
In the current environment, several sources of investment income look increasingly attractive:
Government bonds – up until this year, the extremely low yields offered on ultra-secure government bonds made them rather unappealing to those trying to generate income. The recent run-up in interest rates has changed that calculus dramatically. If you’re a conservative, income-oriented investor more concerned with security of capital than with capital appreciation, now may be the time to take a closer look at building a bond ladder, or putting some money into bond-oriented ETFs and mutual funds.
Dividend stocks – the share prices of many well-established, blue-chip companies have come down considerably since the start of the year. If you’re a more balanced investor who’s looking for both reliable income and some capital appreciation, it’s a great time to go shopping for solid, dividend-paying stocks in sectors such as banks, health care and consumer staples. An added bonus: although their prices can still be more volatile than bonds, the stocks of dividend-producing companies should hold up a little better if the bear market continues, if history is any guide.
Real Estate Investment Trusts (REITs) – REITs are an asset class that has been hit hard by rising interest rates and slowing economic activity this year. But by now, there’s an argument to be made that much of the bad news has been priced in: with unit prices substantially down from the start of the year, it might be a good time for risk-tolerant income investors to start bargain hunting in the sector. Be aware, however, that behind every REIT is a business – and the quality of that business makes a big difference to how volatile the unit prices will be. So, make sure to do your due diligence and research any REIT which you’re considering thoroughly before you buy. If you lack the time or the knowledge or the inclination to do that, stick to well-diversified, professionally managed mutual funds and ETFs.
Keep in mind that there’s nothing stopping you from choosing “all of the above” when it comes to building an income portfolio. In fact, most snowbirds would be well-served by diversifying their income portfolios across all of the above asset classes.
Acknowledge mistakes and clean up your messes when they happen
A bear market is no time to stubbornly hang on to investments that haven’t been working out. During volatile times, when downward price movements can continue to pressure even the best investments, it’s usually far better to acknowledge mistakes, sell your losers and reallocate the proceeds to better ideas, than to hope and pray that one day they will “come back.”
Take a moment now to identify some of the “problem” investments in your portfolio. Are there positions that have demonstrated consistently poor performance? Stocks for which the management or the business fundamentals have radically deteriorated? Ideas that you just don’t feel comfortable with anymore – the risks that keep you up at night? If you’ve invested in new ideas that haven’t worked out as you planned, it’s a good idea to clean up the mess now and move on to new opportunities.
One strategy that can take the sting out of investment mistakes is the ability to claim capital losses: generally, any losses which you take in a non-registered account can be used to offset capital gains taxes on profits that you expect to make in the future (or, in some cases, offset gains which you’ve already made in the previous three years). Doing so requires some detailed knowledge of tax law, however, so make sure to seek advice from a qualified accountant, tax lawyer or other knowledgeable professional before you make any move.
FINALLY: beware of “pervasive pessimism”
Make no mistake: there are plenty of reasons to take a pessimistic view of the stock market, the economy and the state of the world (isn’t there always?). But such a mindset has never been a viable long-term strategy for protecting or building wealth.
No bear market lasts forever. In fact, over the broad sweep of stock market history, bear markets only comprise one out of about every four years. As stormy as things may be right now, eventually the light of clearer skies will creep above the horizon.
Yes, we all need to be aware of events and changing circumstances that pose a danger to our financial goals. But resist the temptation to become a “perma-bear” – the investor who is constantly viewing economic challenges as stock market catastrophes, rather than things that will work themselves out in time. Don’t allow your negative observations to keep you from reallocating your portfolio, investigating new ideas or seizing new opportunities. During a bear market, an investment in optimism could be the best investment that you could ever make.