How to Stand Up to a Bear Market

How to Stand Up to a Bear Market

This isn’t a bear market; it’s two bear markets.

One is menacing younger investors who are still in their saving years. The other is mauling those who are in or near retirement.

For people still in their prime earning years, this bear market is likely to be as bullish in the long run as it is painful in the short run. For older investors, the decline is potentially devastating.

With the Federal Reserve raising interest rates by 0.75 percentage point this week and inflation raging at nearly 9%, US stocks have fallen 22% this year; Bonds are down 11%. Recovery could take more time than some older investors have.

How well you come out of this slump depends partly on how long your horizons are, but more importantly on how you respond. It’s human to feel you have to sell something, anything, right now, before your remaining wealth is smashed to bits. It’s also human to freeze, paralyzed by the fear that any action you take will just make everything worse.

Some brave investors will even see this drop as a chance to buy more assets at lower prices. Others are happy to be earning a decent return on cash after more than a decade of near-zero yields. And it’s important to remember that US stocks, even after this year’s setbacks, have still gained nearly 13% annually over the past decade.

For just about everyone, whether you buy or sell a particular investment right now may matter less to your future wealth than a few durable behavioral changes that can keep you on the right track.

It helps, whenever markets turn worrisome, to look at historical precedents. How bad could things get?

In this case, what US investors should probably fear the most is a replay of the stagflationary slog from 1966 to 1982, when economic growth was spotty, inflation stayed in double digits for years and stocks went utterly nowhere.

On Feb. 9, 1966, the S&P 500 closed at a then-record 94.06. More than 16 years later, on Aug. 12, 1982, it stood at 102.42.

Corporate earnings, after inflation, shrank 15%, according to data from Yale University economist Robert Shiller.

Yes, stocks paid generous dividends, reaching nearly 6% by the end of the period, but inflation devoured them whole.

That period was such an ordeal it turned the individual investor into an endangered species.

In 1979, Business Week magazine declared “The Death of Equities,” and for good reason.

In 1970, according to a survey of households by the Federal Reserve, 25% of families invested in stocks; by 1983, only 19% did. Between 1970 and 1981, the total assets invested in stock mutual funds shriveled to $41 billion from $45 billion, according to the Investment Company Institute.

Worst-case scenarios don’t get much worse than that. Although many investors gave up in those grim years, how did those who stayed the course fare?

We can’t say for sure, because automatic investing plans, which enable you to buy in regular increments over long periods, weren’t widely used in those days.

Had you been able to sink $100 into US stocks in each of the 199 months from February 1966 through the end of August 1982, your $19,900 in cumulative investments would have left you with $18,520 after inflation, according to Morningstar.

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By 1982, the purchasing power of $19,900 in 1966 dollars shrank to about $11,000, estimates operating Nick Maggiulli, chief officer at Ritholtz Wealth Management in New York and author of “Just Keep Buying,” a book on automatic investing strategies.

While investing on autopilot can’t guarantee a positive result, it does enforce discipline.

Investors who plunk all their money down at once are more likely to feel regret and bail out in a bear market. Those who invest like clockwork tend to worry less about buying at the wrong time, making it easier for them to stay the course.

Sticking to a plan is especially important for young investors, whose horizons are long. A plan can help them perceive falling markets not as calamity but opportunity.

Warren Buffett has famously said that investors should think of stocks like hamburgers.

If you like burgers, you should root for their price to go down, not up—and the younger you are, the more meals your future holds.

Likewise, “only those who will be sellers of equities in the near future should be happy at seeing stocks rise,” Mr. Buffett wrote in 1997. “Prospective purchasers should much prefer sinking prices.”

I like to say that the problem with stocks is that they contain the letter T. If they were called socks instead, people would treat a 20% decline in price not as a selloff but as a sale.

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When socks get 20% cheaper, you don’t rush to get rid of the ones you already own; you check your sock drawer to see if you need a few more pairs. Young investors should treat stocks the same way.

To be sure, stocks still aren’t cheap by historical standards.

But young people seeking to build wealth over long periods should be much happier to buy stocks after this year’s 20% decline than they were during the 114% rise that preceded it.

One bit of good news, for younger and older investors alike, is that the yields on income-producing assets are rising.

“Throughout history, the way most people thought about wealth was not in terms of how much you had, but how much income it could produce,” says James White, chief executive of Elm Partners Management, an investment firm in Philadelphia.

As interest rates have climbed, the so-called real yield on long-term Treasury inflation-protected securities, or TIPS, has risen rapidly to 1% this year. That measures tracks what these securities pay investors in excess of expected inflation. It began 2022 at minus 0.43%.

So, points out Mr. White, a $1 million investment in TIPS can now generate $10,000 in annual income, after inflation, essentially risk free. As recently as April, the same $1 million would have produced no inflation-adjusted income at all.

Investors in or near retirement should think of money as “stored energy allowing you to do what you want with the rest of your life,” says financial planner Allan Roth of Wealth Logic LLC in Colorado Springs, Colo. “You want to protect yourself from the possibility of running out of money.”

When your portfolio is down, you may have to step up. That means having to make some sacrifices and defer gratification.

First, suggests Mr. Roth, “retire slowly,” by which he means you should consider taking a part-time job early in your retirement. That will reduce the amount of money you need to take out of your investments when they’re down.

You should also delay taking Social Security until age 70.

Think of it as a guaranteed lifelong inflation-adjusted annuity. The federal government increases what it pays in response to inflation each year, and raises the eventual payouts to any recipients who hold off on drawing their first Social Security check. So deferring the benefit assures you of significantly higher payouts, especially with inflation on the rise.

Your future benefit will go up roughly 6% to 8%, after inflation, for each year you delay, according to Mike Piper, an accountant in St. Louis who runs OpenSocialSecurity.com, a website that helps people determine the optimal age to file for benefits.

During a bear market, it’s vital to spend less; Funding your lifestyle by selling assets that have fallen in price is painful.

Maria Bruno, head of financial-planning research at Vanguard Group, points out that “you can be more flexible with your discretionary spending early in retirement,” when unavoidable expenses like medical bills are likely to be lower.

When financial markets bounce back, she says, you can “adaptively adjust your spending,” taking a little more from your investment portfolios as their values ​​recover.

In the end, whether markets rebound quickly or slowly is up to the bear. How you respond is up to you.

As markets react to interest-rate hikes and the threat of a recession, stocks are dropping closer to bear-market territory. WSJ’s Gunjan Banerji explains what it takes to push stocks back into a bull market and why it’s hard to predict when they’ll turn around. Illustration: Jacob Reynolds

Write to Jason Zweig at intelligentinvestor@wsj.com

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