“A lot happened in 2020” might be an absolutely enormous understatement.
One of the things that happened that year went largely under the radar: a large portion of the US public started their investing journey. A CNBC survey in August 2021 found that over a quarter of all investors had started since the pandemic began.
During that time, stocks were moving steadily upwards – at least, right up until the start of 2022.
This means that for a large portion of investors, this is the first market correction, and potentially the first bear market they will experience.
This has huge implications for what to expect in the next few months as investors react to the emotional experience of the ups and downs of the market.
Let’s dive into what’s happening right now.
What is a bear market?
On May 20th, the S&P 500 dipped into “Bear Market” territory. This means that it had dropped over 20% from a recent high.
Photo by Hans-Jurgen Mager on Unsplash
This is different from a “Bull Market” in which stocks are on an upward trend. For new investors it gets easy to confuse the two. Think of it this way: A bear market is called that because a bear will knock you down to the ground. A bull, on the other hand, will charge and throw you up into the air.
It’s one thing to read about these types of markets, and a whole other to actually experience it. What’s it like to wake up and see that you’ve lost hundreds, or even thousands of dollars in the market over a few months?
How are people reacting?
Inexperienced investors go through a bear market and start to panic. They start to flee the market. And sometimes, it’s for good reason, because their investing strategy was unsound to begin with.
An unsound investment strategy has a couple of different red flags. One of which is that if you are experiencing losses, and you feel the need to sell either because of emotional or financial needs, your strategy wasn’t comprehensive enough.
Most people have been asking only one question about investments: How do I get the biggest return? This question fails to take into account a whole slew of questions related to it: How much risk can I withstand? When will I need the money? What asset allocation suits me best? What are the best tools to reach those goals?
As you can see, developing an investment strategy gets complicated pretty quickly. Not taking these other questions into account leads to an investment strategy filled with knee-jerk decisions. And unfortunately, these lead to exacerbate losses on a personal level, and a country-wide level.
Story: The Inexperienced Investor
Mark started investing in 2020. From social media, he heard about all the gains his friends were making in the stock market, so he jumped in.
At the same time that he started investing, millions of others started investing. This made the stock market go up. Seeing the gains in his portfolio, Mark put more of his money into stocks, along with millions of other people. This makes the market go up, which makes people put more money in, which makes…
You can see that this leads to a cycle, which we experienced for almost two straight years.
But what happens when those same people get scared?
It’s the beginning of 2022. Inflation is sky-high, Russia invades Ukraine, and people are spending money instead of putting it into the stock market.
Mark sees his portfolio stall, and then start to fall.
This is the first time he’s gone through this, so he sell some shares. As do so many others. Which makes the stock market go down more, which scares people into selling, which makes the stock market…
As you can see, we’re trapped in another cycle, made worse by knee-jerk reactions of amateur investors.
What is a sophisticated approach?
A sophisticated investor deals in time horizons: the questions of when do I need this money? A sophisticated investor will create buckets for short-term needs, intermediate, and then long-term needs.
When the bottom drops out of the market, the sophisticated investor doesn’t panic. Why? Because the money they need in the short-term is in much more conservative investments, and retain their value.
Beyond that, the sophisticated investor has systems built in to take advantage of market corrections and bear markets. This might be through a combination of rebalancing and dollar cost averaging.
The sophisticated approach is to have a portfolio that can withstand risk from both a financial, and an emotional point of view.
How do you build a sophisticated portfolio?
If you’re starting to invest and you find yourself worried about the state of the market, you need a financial plan and investment strategy.
This is where a fiduciary advisor can help you out. If you want to see how a fiduciary advisor could help you, sign up for a FREE Bronze Account here. A licensed financial advisor will reach out to schedule a complimentary 1-hour strategy meeting.