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Here we go again. For the past couple of weeks, the stock market’s slide has been dominating the financial news headlines. I’ve begun receiving calls, emails and texts from worried clients asking what they should do in the wake of the 1,500 point drop in the Dow. My first response is to point out that 300 to 400 point daily swings and a cumulative drop of 1,500 points in the Dow would’ve indeed been a big deal 20 or 25 years ago, when the Dow was in the 2,000 to 4,000 point range. However, a 1,500 point slide from the Dow’s recent high of more than 17,000 doesn’t even represent a 10% loss of market value.
Second, to borrow a quip from the charismatic and eminently self-confident boxing great Floyd “Money” Mayweather, “That’s just what Money do.” Simply put, the stock market drops sometimes. In fact, since 1900, the Dow has declined at least 20% from a previous peak—which is the generally accepted definition of a bear market—32 times. 32 times! Honestly, this is not our first time at the rodeo. Though hypotheses about the faltering indices vary, it is a simple fact that the stock market goes down sometimes. It is unreasonable for us to think it would be different this time. If the recent drop turns out to be the next bear market, a 20% decline from the previous high would put the Dow back in the 12,000 to 13,000 range. Don’t be shocked by it—expect it.
In terms of what to do, the “secret” to dealing with a bear market is not to react to it, but to understand that it is a regular occurrence and to prepare mentally and fiscally for the next one. At Financial Planning Hawaii, preparations frequently include some combination of the following three strategies:
1. Investing in reasonably priced, large U.S. companies with attractive current yields and a tendency to raise their dividends each year. Generally speaking, share prices of these companies tend to hold up better during severe downturns, and getting paid to wait for better times may give investors the psychological fortitude necessary to ride out the storm. The tax-favored status of qualifying dividends relative to ordinary interest income may also help keep investors on board when the going gets tough.
2. Allocating some portion of one’s nest egg to tactically managed mutual funds (a.k.a. “go anywhere funds”). These funds typically give the fund manager broad investment flexibility relative to traditional actively managed mutual funds, index funds and ETFs, and a review of the prospectuses often reveals that capital preservation in volatile market environments is a primary objective. Whether such active fund management truly affords value is a matter for debate, but there is at least a fair amount of anecdotal evidence to suggest that at least some funds have been reasonably successful in ameliorating down market risk.
3. Keeping a fair amount of powder dry in the form of cash. Holding cash may make it easier for investors to weather bear markets and enables investors to hunt for bargains when prices are low. For the past several years, the opportunity cost of holding cash has probably never been lower due to the low rates paid on bonds and other fixed income investments.
I hope this commentary lessens readers’ fears, though I know from experience that it won’t entirely. Declining stock markets always make people nervous, and no amount of sensible guidance will change that.