In the event of a bear market, it can be hard for investors to figure out how they should act. However, the principles behind successful investing are actually very simple; and this is still true even during market downturns. In this video, behavioural finance expert JOE WIGGINS outlines how investors can keep a sensible mindset.
TRANSCRIPT
Robin Powell: Contrary to what many people think, the rules of successful investing are actually very simple. Diversify, keep your costs low and focus on the very long term. Two of those things are easy to do, but the third — taking the long view — can be anything but. When the markets have been going down and down, we naturally want to focus on the here and now.
Joe Wiggins: Bear markets are a test, a very stern test, of investor emotions. So when we go through the bear market – when we see losses in our portfolio, when we see news about the economy and about financial markets – we feel anxiety, we feel worry, we feel panic. And what that does is: it dramatically contracts our time horizons. So, for a long term investor, in a bear market; we’re not thinking about the value of our portfolio 20 years hence, we’re thinking about what’s happening to our portfolio right now. The easiest thing we can do to relieve that stress and that worry is to sell our risky investments: to sell our stocks, or to sell our corporate bonds, because that removes and alleviates the stresses that we’re feeling. The greatest temptation, through a bear market, is to remove that worry, remove that short-term pain, but to a great long term cost.
RP: Another problem is that the temptation to sell your stocks increases the longer a bear market continues. The point at which investors are most pessimistic is the worst possible time to capitulate. So what does Joe Wiggins recommend?
JW: I think there’s a couple of pieces of pieces of important behavioural advice for bear markets. One is to go into investing in risky assets with our eyes open. Now, it’s impossible to replicate how we’ll feel during a bear market, but at least if we know, if we’re investing in equities for the long term, we’re likely to go through a number of periods with significant declines and bear markets. So if we have expectations of that happening, then we’re less likely to make bad decisions when it does occur. I think, during bear markets, it becomes ever-more important to try and shut yourself off from the noise, the negativity, and from the willingness or desire for us to check our portfolio consistently. Because, every time we do that, we’re creating decision points. Decision points where we think: what if I just sell this and all this stress and anxiety I’m feeling, I can remove that, even though it might make things far worse in terms of meeting my long-run objectives.
RP: You should also remember that, in general, bear markets are a good time to invest. In the words of the legendary investor Warren Buffett, it can pay to be greedy when others are fearful.
JW: During bear markets, we’re likely to see equities fall and equity valuations improve because markets are getting cheaper. So long run expected returns are generally increasing when markets decline. So for long term investors, that makes it a more attractive time to invest. The problem is that that’s exactly the time when we don’t want to be investing, because we’re feeling so negative and pessimistic and short term. Why would we invest in markets when they’re falling? The best route to dealing with this, and trying to exploit that opportunity, is to try and make sensible, systematic investing decisions and plans. So, before we were in that emotional state of a bear market - if we’re investing regularly into markets, on a monthly savings plan for example, then it takes that decision point away from us and allows a systematic decision to make unemotional decisions into what might be attractive times for long-term investors.
RP: But, to finish, a word of warning. Even if you’re buying stocks that have substantially dropped in value, they may well have further to fall. No-one can predict the markets in the short term.
© The Evidence-Based Investor MMXXIV. All rights reserved. Unauthorised use and/ or duplication of this material without express and written permission is strictly prohibited.