by | Aug 1, 2022

To reap the benefits of gaining long-term market returns, you need to be invested through both the good and the bad.  The magic happens somewhere in between.

Through numerous discussions with clients, it’s very evident that the pain of losses is felt twice as much as the pleasure of gains.  Despite all the information we share about staying the course when markets fall, there are always those who cannot stomach the frenzy and who want to give in to their fear and take control.  This is the most detrimental act.  Let’s explore this in some more detail below, where Victoria Reuvers, MD of Morningstar SA, unpacks this logic and shares some insights to navigate the “distress of the bear”.

What is the secret to successful investing? Many people think it is about picking winners. Some think it is about timing the market while others think it is pure luck.

The theory of achieving investing success through picking winners is born out of the idea that investors can outsmart the market and create alpha. While this may seem like an obvious strategy, it’s a lot easier said than done. In reality, only a tiny handful of managers achieve this and even less so at the same time.

Evidence shows that even financial experts with powerful tools at their disposal can have difficulty outpacing the market. Case in point: Morningstar’s Active/Passive Barometer report found that only 23% of all active funds beat their passively managed peers over the most recent 10-year period.

The sad truth for most investors is that they are unlikely to own these managers at the right time, and if they do, it is likely only a small percentage of their investment.

During times of market extremes (especially on the downside), it’s easy to feel a sense of betrayal from our investments. Not only does this create worry and stress but with it the need to take action and fix the situation.

Let’s take a moment to recap – what is a bear market?

A bear market is defined by a broad market index falling by 20% or more from a recent high. And as of market close Monday, 13 June 2022, the S&P 500 index officially hit bear market territory. It’s down more than 21% year-to-date.

Although a bear market is declared once the stock market falls at least 20% from its previous high, the entire decline is considered part of the bear market. Similarly, the following market rally, or bull market, is declared once the market reaches a new all-time high, but it includes the entire recovery from the low point of the bear market.

What causes a bear market?

A bear market is essentially a crisis of investor confidence, the causes of which can vary. The most common trigger of a bear market is rising interest rates which results in a weak or slowing economy, or the anticipation of an economic slowdown.

Signs of a slowing economy may include:

  • Falling productivity
  • Rising unemployment
  • Low disposable income
  • Low consumer confidence
  • Decreasing corporate profits

What to do during a bear market?

Bear markets tend to induce behaviour that makes us do more with our investments than we should and generally lowers our probability of success and achieving what we set out to do – which is of course to generate long-term wealth.

If investors are concerned about falling returns, they may be more inclined to sell rather than hold or buy shares. A sell-off can then trigger further pessimism about market performance, acting as a negative feedback loop that sends the market into decline.

There are many strategies and tips for surviving a bear market. I have summarised a few below that I find particularly helpful:

1. The markets aren’t out to get you, so don’t take offence

It’s easy to internalize market moves but the key is not to take them personally. In the words of Ben Carlson “We all feel like geniuses when markets are rising and idiots when they’re falling but the truth is always somewhere in the middle”.

If it was simple to always make good investment decisions, there would be no need for active managers.

Once you have skin in the game it changes your relationship with your investments. This is why we feel more comfortable taking risks when things are rising than when they’re falling.

A study by Daniel Kahneman and Amos Tversky showed that we feel the pain of an investment loss twice as much as we feel the pleasure of a gain. The pain of loss is real. It’s emotional and we want something or someone to blame. However the market doesn’t care, but you can take some comfort in knowing that you are not alone.

2. If your goals haven’t changed, neither should your investment strategy

Unfortunately, long-term investing is not a trip to Vegas and is actually quite boring. The get rich trick to long-term investing is simple – invest your money, sit tight and let it grow over time. That’s also where the added benefit of compound interest starts to work its magic the best.

If your investment goals and time horizon haven’t changed, neither should your investment strategy. If in doubt, look at your investment values and market prices less often. Yes, that’s a cheeky statement to make, but it’s true. If you have a five-year investment horizon, what good does it serve you to worry about the values in the first year?

3. Tune out the noise

“Tune out the noise” may well be sound financial advice but it is a lot easier said than done. Instant market updates and shocking headlines stream our way via news channels that have access to almost every outlet we consume – from print to social media. The media is designed to evoke emotion. In most instances, we are left feeling worked up and helpless with no clue how to react.

In the words of Tim Tebow – “Don’t worry about what you can’t control. Our focus and energy need to be on the things we can control. Attitude, effort, focus – these are the things we can control”.

The mistake investors make is thinking that their investments are the part(s) of the puzzle they can and should control. We view it as the one area that we can change – we can disinvest from old-fashioned investments that are not performing as well as they used to and buy the coolest company shares on the block that are outperforming.

The reality is that markets are forward-looking. By the time you buy the best performing shares on the market, the market has already reacted and priced in its forward-looking view. Not only have you sold your “old-fashioned investments” at a low price, but traded them for the cool-kid shares at a very expensive price. All your action does, is lock in and crystalise that short-term loss.

4. Trust the process – even if it doesn’t look picture perfect

The pain of capital values that are 20% lower than they were in December is real and enhances one’s own desire to act. The temptation to take control and make a change is real.

Yes, the current market conditions and economic environment are both challenging and uncomfortable; but we have been here before and we will be here again.

It is critically important to remain invested, through good and bad times. Often the worst days in the market are followed by the best days. Unfortunately, you need to be invested through both the good and the bad to reap the benefits of gaining long-term market returns, which translate into wealth creation over time.

Regardless of how much you invest, if you just have the patience to let your investment compound and the discipline to continue saving through good, bad and boring times and not get distracted, you will be amazed by the power of compounding over time. It is in fact, the eighth wonder of the modern world.

In closing

We believe that investing is a long-term pursuit, patiently allocating to assets that will help you achieve your goal. So, if you catch yourself getting down about the state of the market, trying to predict what’s next, or getting bored with your investments, always remember why you are investing in the first place.