Train your brain for a real bear market


The optimism of late summer has quickly faded in the financial markets as investors are getting the sense that the Fed isn’t inclined to stop beating up on the economy any time soon. Inflation remains way too high, and the Fed is determined to bring it down using the sledgehammer of higher interest rates. The rapid increase in rates has caused stock and bond values to fall this year, and real estate may not be far behind.

While the returns have been ugly this year (negative 22% for stocks as of the time I’m writing this column), we aren’t even in serious bear market territory yet. The average decline in the stock market during a bear market is about 35%.  That’s the average, which means half of the declines are worse than that. For instance, in the financial crisis of 2008, the market declined about 57%, and in the tech crash of 2000, about 50%. If you are feeling uncomfortable now, you should consider training your brain for bigger potential declines.

Charlie Farrell

Photograph by Ellen Jaskol

Charlie Farrell

The reason you need to train your brain is because this is primarily a psychological game. If you can look beyond the declines to an eventual recovery, you can maintain your commitment through the cycle. But getting there is tough as you watch your hard-earned savings shrink.

Just like an airline pilot trains in a simulator for emergencies, you have to train yourself to handle difficult market conditions. We know that for most people, declines feel twice as bad as gains feel good. Thus, you can experience a lot of mental distress if markets fall hard. If you don’t prepare, then you are likely to make poor decisions at the wrong time.

Now, there are no guarantees of a market recovery, but there are no guarantees in just about anything in life. The financial markets present you with a range of potential outcomes, and you should consider positioning yourself for the more likely longer-term outcomes. The odds of the stock market recovering within, say, three to five years are quite high. Historically, markets have recovered, so it’s reasonable to assume they will again. Thus, you need a basic confidence that the system bends but doesn’t break. If you don’t have that confidence, then the field of finance doesn’t have much of an answer for you. It’s built on the assumption that things recover and get better over time.

So, if you have that basic confidence in your gut, then work on training your brain. Put on paper how much you have in your stock portfolio now, then write down what it looks like if your portfolio falls another 20% or 30%. Envision the decline and accept it as part of the path toward building your longer-term wealth. I know it’s not fun, but it’s better to train your brain than not, and find yourself in a panic situation.

Instead of looking only at stock market declines, let’s say you have a balanced portfolio between stocks and bonds. The traditional balanced approach is 60% stocks and 40% bonds. With the bonds, you’ll get some defense, but in a big market unwinding, the declines are still going to hurt. So even if you have a balanced portfolio, you should be prepared for what you might experience.

You may have seen charts illustrating the biggest calendar year declines for balanced and globally diversified portfolios. The number is roughly a negative 23%. But those charts are calendar year returns. Since most of us look at our portfolios more than once a year, to get a sense of the true decline you might see, you have to run the numbers on a daily basis. When you do that, the decline is negative 38%. Wow, that’s a big difference.


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