Bear Markets Aren’t Bad
The world seems to be going mad! And this is nothing new. The stock market is reacting to a litany of issues and has plunged into bear-market territory: 20% down and more. The media, aptly named the Financial Pornography Network by Carl Richards, is howling about the crisis and prognosticating about how bad it can get. And I am sitting here excited about what this all truly means: the opportunity of a lifetime.
In this episode we cover:
A Bear Market is Not a Crisis
You’ve likely heard the shrieking of the media on the current crisis de jour—statements like “The worst start to the year since 1939” and the like. The howling will only get worse as we plunge into a bear market. So before we get into the opportunity, we need a refresher on market declines and how we ought to think about them.
Bear Markets, a 20% decline in the value of the stock market, are common as dirt. They happen every five years on average, though not like clockwork. The declines are part of the volatility, and the volatility is what generates our returns. I repeat it:
This is where we earn our returns.
We need the volatility to generate superior returns. Flat interest rates and guaranteed growth must always be lower than equity returns. No one complains about the upward volatility. No one griped when S&P generated a 28% return in 2019, over 18% in 2020, and 22% in 2021. Or did we just forget about all that? It’s only when the market descends that people panic and think they are losing money.
And that is a key distinction, one we must hit over and over again.
There is a world of difference between a decline in value and a loss of money.
The value of the best business in the world, as measured by what people are willing to pay for them, has declined from the all-time high. This doesn’t mean that you have “lost money.”
If the value of your home goes down a bit when a housing market slows, does this mean you have “lost money?” Of course not! Neither do you panic because you don’t even see that decline. We panic about our equities because we can constantly see their value.
The only way to lose money is to sell equities when they are down.
You turn a temporary decline into a permanent loss.
This is a natural part of owning the best businesses in the world. If you cannot stomach a recurring (albeit temporary) drop in value every few years with the help of a tough-loving and empathetic behavioral investment advisor, you cannot be an equity investor. Nor a bond investor, as we’ve seen. Keep your money in cash, and be ravaged by inflation.
Since cash is clearly the worst of all long-term solutions, you must endure the downturns. The best way to do that is to ignore the news and keep a steady diet of belief- and behavior-reinforcing messages to stay the course. That’s what we’re here for.
It is okay to be scared. It’s okay to be anxious. All of that is normal. What is not okay is to act on that fear. Fear is not a good investment policy.
We don’t know when this bear market will end. All we know is that it will end, if the weight of history is any guide. Which brings us to the good side of the coin.
“Selling Equities when they are down is the only way to turn a Temporary Decline into a Permanent Loss.”
~Nick Murray, Legendary Financial Advisor
A Bear Market is an Opportunity
There are two main opportunities tied to bear markets
Buy Low in a Bear Market to Capture the Recovery
“Buy low and sell high” is the mantra of the investor. And while traders and speculators believe this means buying and selling over short periods of time, we investors know this means buying whenever we can and selling a long time from now when it is worth many multiples of what we bought it for.
Well, the market is relatively low.
How many of you have looked back at the past at the Covid Crash, the Great Financial Crisis, or the Dot Com Crisis and wished you had invested at the bottom. You see what you could have made on the recovery, and you dream of the what-ifs.
We have no idea where the bottom of this market will be. But we know that it is on sale now. And here is an important point:
The recovery is worth more than the decline.
It takes a larger recovery to make up for a decline. If $100 loses 20%, it loses $20 and is worth $80 (20% x $100 = $20). But if $80 gains 20%, it only gains $16 and get’s back to $96 (20% x $80 = $16).
- It takes a 25% gain to make up for a 20% loss.
- It takes a 33% gain to make up for a 25% loss.
- It takes a 43% gain to make up for a 30% loss.
Whether we bottom out at around 20% here or it continues to drop further before it rebounds, any investment in the market at this point will eventually see superior returns.*
When will it rebound? Who knows! Does it matter? No! Whether it takes six, twelve, eighteen, or twenty-four months to recover, earning 25%+ over that timeframe is fantastic!
And there seems to be a historical correlation between how fast a market drops and how fast it rebounds.
- Dot Com Bubble: 25 Months Peak to Trough (Down), 50 Months Trough to Recovery (Up).
- Global Financial Crisis: 18 Months Down, 36 Months Up.
- Covid Crash: 1 Month Down, 5 Months Up
We are six and a half months into a decline. If we are nearly at the bottom, the recovery may be so fast that we are likely to miss it. And there is another reason to invest now.
We may never have an opportunity to buy in at this price ever again.
This bear market may be the last time you can buy the S&P 500 at under $4,000. When this recovers, it will likely never drop below that point ever again. This may be the opportunity of a lifetime to invest in a market that will eventually top $5,000, $10,000, and beyond.
If you have cash or other short-term investments, and if it fits into your overall financial plan to invest those into the market, there is a flash sale going on right now. Perhaps you should take the opportunity.
But what if you don’t have any excess cash lying around. What if you are already invested in equities, and they are all down right now. What else can you do?
Complete Roth Conversions in a Bear Market to Maximize Lower Brackets
Whether you should do Roth Conversion or not is beyond the scope of this episode. We covered it already in Episode 44 in November. And you should definitely consult with your comprehensive financial planner on whether it makes sense for you. But assuming you should, bear markets are the best time to do it.
Two quick points:
First, there is no limit to the amount you can convert from IRA to Roth. There are contribution limits, not conversion limits.
Second, you don’t have to convert cash. You can convert shares of existing securities.
You can convert a greater amount of shares from your IRA to Roth when the shares are worth less.
Let’s say you wanted to convert $100,000 to Roth, but doing so would cross over from the 24% tax bracket to the 32% tax bracket. Suppose that only $70,000 would be taxed at 24%, and the remaining $30,000 would be taxed at 32%. That’s $1,800 more in taxes on that last $30,000.
But if the value of those securities temporarily dropped by 30%, they would now be worth $70,000. You could convert the whole about inside the 24% bracket. Then when it recovers back to $100,000, it will have done so tax-free.
Bear markets present an opportunity to convert more shares at a lower tax rate and save taxes.
Consult your comprehensive financial planner about whether it makes sense for you to complete Roth Conversions.
Bear markets are not crises. They are opportunities. Remember, as legendary financial advisor Nick Murray says:
All failed investing involves constantly reacting to the market.
All successful investing involves continually acting on a plan.
Have a plan. Stick to the plan.
*This is not investment advice, and there is no guarantee of the market returning. Nor is there any guarantee that we won’t all be blown up by nuclear bombs tomorrow. Nothing about the future is guaranteed, but if you need this disclaimer, here it is.
This article is educational only and is not intended to be investment, legal, or tax advice or recommendations, whether direct or incidental. Again, this is not investment advice. Consult your financial, tax, and legal professionals for specific advice related to your specific situation. Never take investment advice from someone who doesn’t know you and your specific situation. All opinions expressed in this article are the opinions of the people expressing them. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. RetireMentorship is not affiliated with any Registered Investment Advisor, Broker-Dealer, or other Financial Services Company.