After years of steady climbing, the U.S. stock market seems to have hit a temporary peak.
Stocks on the major indices have fallen by hundreds of points and recently erased the year’s gains. But is that a correction, a bear market, or something in-between?
More importantly, should investors “do something” about their portfolios now?
Investors like to define a bear market with something comforting, such as an exact number. One number often bandied about is a 20% decline from a peak.
A correction, meanwhile, is supposed to be only a 10% decline.
That said, the only real definition of a bear market is one in which selling fuels more selling. It’s not about the stocks anymore but what other investors are doing.
The idea of a bear market, and a bull market too, thus suffers from the “I’ll know it when I see it” problem of definition.
The nearest economic corollary is how we measure recessions. The group that tracks recessions officially, the Bureau of Economic Analysis (BEA), famously refuses to name a recession until well after one ends.
Even hurricanes get named while they’re still tropical storms, so why wait?
Because the definition of a recession is a time when economic growth slows consistently and then, eventually, bottoms out and growth resumes.
The BEA needs a recession to clearly end in order to properly define its length and depth.
Bear markets are no different. Stocks might continue to fall, then recover a bit, then fall again. Only after we see a decided end to the downward pressure can anyone say, well, that was a bear market.
In the meantime, at least some investors are taking falling prices not as a warning but as an opportunity to buy. Somebody’s wrong here, but who?
The data show that bull markets last considerably longer than bear markets — 9.1 years on average vs. 1.4 years. And the gain in a bull market is much bigger, a cumulative total return since 1926 of 480%, compared to a cumulative loss in bear markets of -41%.
The trick for long-term investors is to be buyers in down markets, to get stocks as prices fall, rather than only when they rise.
The way you do that is to dollar-cost average, just buying stocks in equal dollar amounts every paycheck, month, quarter or year.
It is extremely difficult to pick the right market, but buying stocks in a volatile time is really just buying low. Owning a portfolio and rebalancing it like clockwork smooths out the rough patches.
Finally, if you are nearing a point where you might need take income, that’s the time to sell stocks and instead buy income-producing investments, such as bonds.
You might be selling even as the market goes up, and that won’t feel great. But you will be taking well-earned gains and there’s nothing wrong with that.
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