While I don’t believe that a bear market is coming, one big lesson from the last two recessions is that it can’t hurt to be prepared.
Crashes will always come and go. Whether it’s 6 months or 6 years from now, nobody really knows. The prospect of me becoming a thousandaire again is not beyond the bounds of possibility.
As a Generation X-er, I’ve been at ground zero of 2 big market crashes: the Dotcom Bust of 2002 and the Housing Bust of 2008. Both were followed by deep recessions. The great recession of 2008 was way deeper, but the recession of 2002 could be just as deep– if you happen to work in the tech industry just like I do.
In the summer of 2000, I left my job in Philly to work for a software company that sells analytical tools to fund managers. The company was headquartered in Research Triangle Park, NC –the tech hub of the south. They collect data from investment companies that manage funds pooled by individual investors (i.e. mutual funds) and translates that into useful information.
Times were pretty darn rosy in that the company even paid for my relocation plus some generous sign-in bonus. There was “irrational exuberance” as massive euphoria was everywhere, investors were buying internet companies left and right that have ridiculous valuations. The NASDAQ index rose from 1,000 to almost 4,000 at its very peak.
But sometime around March that year, it came to a crashing halt. The bubble, which had been building up since I moved to the states, slowly started to pop. People lost faith. Stocks sunk. With less and less money to manage, fund managers who have been buying software licenses from us suddenly had to cut back on their spending causing our sales revenue to plummet. I had a strong inkling of a sinking ship and boy I was right!
Except for the fact that…
I resigned a few hours before I was supposed to get laid off!
In a bizarre case of bad timing, I submitted my resignation letter just a few hours before my company announced the massive employee layoff. My immediate boss happened to be on vacation that terrible day (maybe on purpose), so I had to give my two weeks’ notice to his boss who happens to have a stake in the company’s bottom line– there’s no chance he’s going to give me a hall pass on severance pay.
The ‘firing’ process went something like this. A memo appeared on our inboxes telling us which room to go: room A or room B. I was asked to go to room B. Once there, an HR personnel told us that we’re in room B because the people in room A will be given their pink slips.
There was complete silence in the room. We know this will happen but not so soon. There was a sense of relief at first. And then people were in tears, especially the ones that were friends with the people in the other room. I couldn’t help but think about the friend of mine who just bought a house. But in retrospect, I felt bad for everyone.
As for me, I literally didn’t know whether to laugh or cry…
– The good news was that I already accepted a contract position elsewhere that pays $50 an hour.
– The bad news was that I didn’t get my severance pay– I officially resigned, not laid off.
– The worse news was that I had to work for 2 more weeks to fulfill my obligations. Ugh!!!
Later that day, the whole office was talking about my good but somewhat bad timing.
How not to fear the next market crash
When crazy things happen, always expect the worst. Companies can layoff people at any time, but it can become the norm during a recession– hardworking people can lose their jobs. When people lose their jobs, they spend less– much less. And when they do, companies make less money causing them to layoff more people. It’s a vicious cycle.
As an investor, however, you should learn to embrace bear markets– these are the greatest window of opportunity in your life to leap frog from where you are to where you want to be. When the market drops 20%, 30% or 50%, then you’d be buying shares at a discount. Think of it this way, if bear markets were IPhones you’d be rushing to the nearest Apple store!
Here are some facts:
- Bear markets generally occur every 4 to 5 years
- Every single bear markets are followed by bull markets
- The worst thing that you can do is stay in cash (read this Charles Schwab study).
Keep your portfolio well-diversified
Diversification essentially means investing in a mix of asset classes to ensure you are not in serious trouble even if you lost a significant amount of money on one of your investments. This is because any losses, incurred on any of your investments, may be offset by gains earned by other assets.
Being diversified can help cushion against losses, and that’s a precaution that you can take now. Increasing your allocation in bonds, for example, helps soften the effect of a market crash on your portfolio because they are usually inversely correlated to stocks.
You should rebalance your portfolio like a dentist every 6 months to match your goals.
Stay the course, don’t miss out on market rebounds
Many investors sold at the bottom of the bear market in March of 2009, turning temporary paper losses into real, wealth-shattering losses.
According to another Schwab study, if you had invested $100,000 on January 1, 2009, but missed the top 10 trading days, you would have had $43,000 less by the end of the year than if you’d stayed invested the whole time. Your timing might end up much worse than mine!
Make cash an integral part of your portfolio
Cash reserves will come in handy in down markets. With cash, you can buy when prices are relatively low, without having to sell any of your existing positions at a loss. Cash can provide your portfolio with a sense of stability and offers protection against volatility. It helps mitigate downward risk.
In my case, I’m setting aside at least 10% of my portfolio in money market accounts. But that’s just me, run your own numbers.
Beef up your emergency fund
In a recession, 3 months won’t do. You need at least 6 months worth of expenses. Beefing up your emergency fund helps keep your stress level down. Being prepared gives you the confidence that you need to tackle any of life’s unexpected events like a job loss during a recession.
I eventually lost that contract job that paid $50 per hour. The original 6 months was shortened to a few months due to spending cuts. But guess what I did?
Instead of rushing to find another job, I toured the whole continental United States for the next couple of months! All because I had my emergency fund in place.
Have no fear.
Learn how to protect your portfolio in a downturn.
Here’s a great book that I recommend.