“I’m very nervous about this market.”
So began the letter from Tom that came in this week to the Investment U Mailbag. He continues: “I’ve done pretty well in the markets since 2010, and I’ve regained a good chunk of what I lost in the 2008 crash. But I don’t want to go through that again. I’m 55 and would like to retire in the next 10 years. What should I do?”
With the S&P 500 falling sharply during the second half of January, some shell-shocked investors are experiencing the financial equivalent of Traumatic Stress Disorder.
Last week, investors pulled more than $22 billion out of stock ETFs, including some $10.7 billion out of the SPDR S&P 500 (NYSE: SPY). They put an equal $10.7 billion into taxable bond funds, which was a record.
So I hear you, Tom. You’re not alone in your concern. And I can’t say whether we’re headed for a bearish period or not. But we know that markets head higher over the long term. During any 10-year period over the past 75 years, the only way you didn’t make money in the markets is if you sold during the depths of the Great Depression and Great Recession.
We also know that investors frequently overreact to short-term market declines, and lose money by selling just before the recovery.
The American Association of Individual Investors Sentiment Survey is showing the lowest level of bullishness since April 2013.
Do you remember what happened after April of last year? The market immediately rallied 8% higher over the next five weeks and ultimately went up 19% over the following nine months.
Yet the mainstream media fuel this negative thinking. I nearly drove off the road last weekend when a financial talk show host said investors lost half their money in the bear markets of 2000-2002 and 2007-2009.
Let’s be clear about something. “Investors” did not lose half their money in those bear markets. The only people who lost half their money were the ones who sold at the bottom. Long-term investors – while they suffered a serious case of agita – recovered every nickel and then some within a few years, just by doing nothing.
So don’t panic, Tom. Instead, take these three steps to ensure you don’t take a massive loss in the next bear market.
1. Don’t sell. If you don’t need the money that’s invested in the market for the next five years or so, leave it alone. When everything feels like it can’t get worse, take a deep breath and start buying. It always pays to buy fear. That’s where fortunes are made in the market.
Think about what your portfolio would look like today if you bought stocks in early 2009, instead of waiting until 2010.
2. Place stops. If you know that you emotionally can’t handle big drops, place a stop loss that will get you out of stocks if things really get hairy. The Oxford Club’s policy is to set a 25% trailing stop.
This enabled us to get out of stocks during the Great Recession with big gains and made room in the portfolio to add stocks as prices slid lower, giving us great entries into some cheap names.
3. Don’t invest money that you need in the next three years. If you will need the cash that you have invested in the market in the next three years, take it out now. Not because I think the market is going lower, but because a correction or bear market can occur at any time. If you need the money in the short term, the worst scenario would be to have to sell as the market is bottoming.
Using these steps will get you out of the market when you should while still letting you take part in the big rallies that often come after bear markets.
P.S. Have a question for our mailbag? Leave a comment below.
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