When average investors experience a bear market, they often lose their long-term focus and become overly concerned with short-term uncertainty.
Some time has passed since investors have experienced a true bear market. Some of you may have experienced the 1987 and 1990 bear markets, while others may only remember the bear that occurred in September of 1998.
It is important to understand that these particular market declines were not traditional bear markets. A traditional bear market is classified as a decline of 20 percent or more that historically lasts an average of 14 months. Between 1946 and 1981, there were seven traditional bear markets, each lasting approximately 14 months. The S&P 500 market declines of 1987 and 1990 were 36.1 percent and 21.2 percent respectively, but were very short in duration. The 1987 decline lasted two months, while the 1990 decline lasted three months. The decline in 1998 was 12 percent and lasted one month.
Between January 2000 and March 2001, the Dow declined approximately 20 percent. How does the current experience stack up? Fourteen months and a decline of 19.9 percent are consistent with a traditional bear market. The peak for the S&P 500 occurred in March 2000 and its low occurred in April 2001. The S&P 500 was down 28 percent from peak to low; the NASDAQ Composite also reached its peak in March 2000 and its low in April 2001, reflecting a decline of 67.5 percent. (These percentages do not reflect the market decline that occurred after the events of September 11.)
Where do you go from here?
Many investors are experiencing their first bear market. Although they understand that the market fluctuates, this bear market has been very powerful. Investor behavior may reflect this fluctuation.
Dollar-cost averaging does not assure a profit and does not protect against a loss in declining markets. In addition, because such a plan involves continual investment in securities, investors should consider their financial ability to continue purchases through periods of low price levels, regardless of fluctuating price levels of such securities. With or without dollar-cost-averaging, the buy and hold idea is a very simple one for an investor to implement; it has historically proven to be quite a successful investment strategy. (Please remember, though, that past performance is no guarantee of future results.) But it can be a challenge to remember this strategy during down periods. Plus, it is not an easy strategy to implement. When average investors experience a bear market, they often lose their long-term focus and become overly concerned with short-term uncertainty.
By "muzzling" the bear, your chances of survival increase. How do you muzzle the effects of a bear market?
Don't look at only the last five or 10 years of relative performance. If all investors had to do was look at relative performance to pick the best investment, life would be easy. Matching your portfolio strategy with your long-term financial goals is the first step in muzzling the bear. Understanding asset allocation, and how it fits into your financial plan, can help you to better understand your temperament toward investing.
Work with a financial advisor. A financial advisor can help you understand how investment managers deal with declining markets.
Determine which approach best suits your financial goals. Again, your financial advisor can help you implement a strategy that meets your needs and suits your goals.
Never underestimate the power of a bear. Financial planning, asset allocation, and annual reviews with your financial advisor may help lessen the effects of a charging bear market. Perseverance, a long-term perspective, and diversification can help "muzzle" the bear.
A recent study by the Consumer Federation of America reveals that consumers who develop specific financial plans nearly double the amount they save compared to those who do not.
This study shows that taking the time to identify your needs and developing a plan to meet your financial goals may help you realize those objectives.
Kathleen Adams, RDH, BS, is a financial adviser with Waddell and Reed (www.waddell.com). She is currently trying to initiate money-management workshops for hygiene students and specializes in working with dental professionals. She can be reached at (800) 210-1357.