Bear Market Edition
When that bear came after you, and you saw your investments drop thousands of dollars in a matter of weeks, or even days, what choice did you make? Did you decide to sell before the storm got worse, and try to preserve what you had left? Then maybe you bought back in at some future time when the market had finally recovered? Or did you ride that sucker all the way to the bottom, buying as you go, hanging on for dear life and locking in stocks on sale! Only to grab the reigns, then ride that beast of a bull all the way back up to the top* again, profiting from the gains of cheaply gotten stocks?
If you own individual stocks, like say Walmart, Apple, or even lesser known small cap companies, then it may be more on the frightening side to experience a market nose dive. Regardless of what people say, you can’t predict which company may plummet completely but never recover, thereby actually losing the money you invested in them (RIP Sears). Whether it’s due to things like poor business decisions, lack of diversity, or even scandal, it has happened in the past and it will happen in the future.
However, if you own the entire stock market with an ETF like Vanguard’s VGRO, then the answer for how to behave in a crash is fairly clear. Ride it to the bottom, and right back up again. If some companies go out of business, that’s all part of the game. They’ll be replaced by others, but the underlying market will not fail… Hopefully. If it does, then we’ll have bigger problems to be concerned with. But staying the course is easier said than done. That’s where human emotion comes in to play and where problems begin. Fear, greed, anxiety, herd mentality. So until you actually experience a crash, you can only guess what choices you’d make until your actually living in that situation.
My First Crash
I’ve been personal investing for a number of years now but had never experienced a true crash. I had always been fairly confident in my ability to weather one, and thus my own asset allocation has been fairly aggressively positioned, the majority in stock ETFs over bonds. I was finally treated to a market crash during the first round of COVID-19 in February 2020.
Your first crash is basically the big test for all investors out there. They say you don’t really know what your own personal risk tolerance is until you’ve experienced one and found out how you truly react to it. My own experience went quite well. I was able to continue buying low throughout, without feeling the need to sell or panic, re-balancing my asset allocation where necessary. There is something cathartic though about seeing all your invested profits suddenly wiped out. Perhaps “loss in value” is a better descriptor. Because I didn’t own any individual stocks, there wasn’t any real risk of losing invested position, apart from doing any panic selling. Which I didn’t.
While that crash my not have been as significant nor taken as long to recover at the 2008 housing crisis crash, it was still a fairly big deal and a descent test of any investor’s perseverance.
Factors At Play
The market recovered (in almost record speed), all the losses were replaced and then some because of the opportunity we had of “buying low”. I had a few factors backing my commitment to staying the course.
-I currently have no debt.
-I don’t use leverage for investing
-I had a permanent in demand job.
-I had an Investment Policy Statement (IPS)
-I spend notably less than I earn, allowing a large regular, savings (investing) rate.
While all of these are relatively important and some require stories for another time, in regards to investing, the IPS is one of the more important items. You are supposed to design an IPS around your own individual circumstances, thereby determining your own risk tolerance, goals and beliefs.
The main benefit to one is it helps tame any emotional instability you may have during rocky events like bear markets, by providing you with an already set plan of action, no matter what the market does. And the big point is that you’re supposed to stick with it, and not mess around with it too much arbitrarily, otherwise your plan ceases to be plan, and investing becomes a loser’s game.
An Opportunity
The current bear market/crash of May/June 2022 has been brought on by multiple factors including, blistering inflation the likes we haven’t seen in a number of years, caused by COVID-19 side effects of supply and demand, oil prices due to Russia’s war with Ukraine, and various other factors like the extreme housing bubble we’re in.
Well, I was feeling a bit different about this crash than the last one. Not that I plan to sell and get out of the market now. That would be the worst decision one could make. But I have been having feelings of the opposite. How to get “more into the market”. It’s like I’m having some of the fear of missing out syndrome. The S & P 500 was down a good ~20%, with the TSX not too far behind, classifying at least the S & P as entering a Bear Market. If you’re not currently retired, then this just means the market is on sale again. A golden opportunity.
While I’m able to contribute a decent chunk of my monthly income to my TFSA, to me it still feels like a drop in the bucket compared to the potential of the market rebound we’ll eventually get. Just looking at the March 2020 crash, any ETF shares bought in the S & P 500 at the bottom would have increased over 60% in value by the end of the year. My own investment plan calls for an 80/20 stock-bond split. One of the ideas being to have one asset class (bonds) that doesn’t completely correlate with the other (stocks), thereby re-balancing to help smooth some of the market volatility while maintaining a fairly good rate of return.
By keeping a ratio like this by buying or selling as needed, it encourages you to buy low and sell high. But this time around, because of the high inflation numbers, the bank of Canada has also been raising interest rates to help not only calm inflation, but also to cool down the hot housing market as well. These factors have seemingly contributed to the bond ETF I own also plummeting nearly as significantly as the stock portion. So it’s been a bit tricky to do any re-balancing when everything is currently low.
Chasing Returns (AKA Bond ditching)
An idea I was tossing around is what if I converted a bunch of the bonds over to stocks, so when the stocks rebound I’ll nab a higher return than keeping the bonds as is. The problem with this though, is that it’s getting into market timing, and predicting the future. While stocks have typically outperformed bonds in the long term, that doesn’t mean that this will continue. The bond ETF might just as well recover as fast or faster than the stock market. Even though older bonds may take a hit with increased rates, the new bonds with the higher rates will eventually replace the older ones causing the ETF to recover.
Digging further into this, for the stock market to return to it’s prior bear market levels at this point, it would have to increase ~25%. So let’s say I took $5000 of bond ETF, sold that, and bought the equivalent in stocks. With a 25% rebound, the $5000 would become $6250. So, a $1250 net. Not really a large gain from a dollar amount perspective. However, just leaving the $5000 in the current bonds, when that ETF recovers, the $5000 would be $6250 anyway. So there’s a large possibility of it all being a wash.
Also, I had the idea of selling ALL my bonds in my portfolio, converting to 100% stock allocation, as everyone on the internet seems to be “getting out” of bonds, or not buying them because the return has been so terrible with low historic rates and also increasing current rates. But this gets into yield and return chasing without factoring in overall individual risk and comfort level.
While everyone and their dog seems to be a pundit, there are people wiser than me have stated multiple times that bonds aren’t for chasing risk or for having optimal returns. They’re more for helping to stabilize or lessen risk in your portfolio for events like crashes, helping one to stay the course. And for the case of 100% equities, that should be reasoned and stated in an individual’s investment plan. Mine currently does not have this, and changing it frivolously on a whim to chase higher returns is not likely a wise idea.
Leveraging the Great
Of course, this got me thinking of a grander idea. Leverage. With the recent real estate bubble we’re in, there’s a lot of potential home equity in my house that could possibly be unlocked, and thereby invested into the bear market in an effort to super charge investment returns.
Leveraging finances presents a much larger risk, with potentially larger reward. I doubt it would be difficult to get a loan for a couple hundred thousand out on a HELOC, or even a mortgage cash out plan. Let’s say I bought $200,000 of stocks with this amount right now. If the market suddenly recovered that 25%, then by $200k would be worth $250,000. That extra 50K would be pretty sweet!
The Tortoise and the Hare
There’s a few “problems” with this strategy though. First, there’s nothing from stopping the market from going lower than it is now. In fact, there’s a very real possibility we haven’t hit the bottom yet. That 200k could easily be worth 150k or less, and I would be “underwater” on the HELOC. If the bank decided they wanted their full loan back immediately, well, that would suck, immensely. And this issue is magnified the larger the leveraging amount becomes.
Also, it seems like the era of essentially “free” money, (aka super low interest rates) are at and end. Whereas for quite a long while you could obtain a mortgage rate for under 2%, the prime rates have now increased to the point of 4% or higher. And since HELOC rates are usually more expensive than mortgage rates, that’s not good news either. A 200k loan, would potentially cost ~8k per year in interest. While some of that could be tax deductible, I’d still have to make a decent market return for the risk to be worth it. If the market returned 6%, that’s really only 2% after the loan interest cost.
That would work out to ~4k on the 200k loan. That’s not very much considering the risk for further market crashes and loan call backs. Even an 8% or 10% return still seems a bit low for the leveraged risk taking, considering where the Bank of Canada prime rates are headed. Also the fact that 20% of my portfolio is on bonds, which are currently in the toilet and about to be flushed even more. It’s also been said that before going the route of leveraging, one should be 100% in stocks, as they provided the best overall return. What’s the point of paying more interest on a loan than the bonds themselves are returning (much risk for minimal/negative reward).
So, in regards to the leveraging idea, since it’s very tricky to predict the future, and thus market time correctly, a large loan like this for investment purposes in the current conditions seems like not the wisest idea either.
More often than not, the most successful way to invests long term is to go with the average of the market, as opposed to trying to chase down all the “winners” all the time. While this can look like the slower, less exciting approach, it’s usually more successful than speculative, return chasing strategies.
In a way, you can always predict what the market average will be, as it will generally always be… Average!
A Win – Win situation
If you are still in your accumulation phase of investments, and not yet retired, then anytime is a good time to be in the market. If the market goes up, so does the value of your investments. Even if each individual stock purchase costs more, your net worth still goes up. And when the market goes down, naturally your net worth will as well. But the beauty of this down turn is the massive market sale that occurs with ample buying opportunity. And when the market finally does upswing again to previous levels and beyond, not only will your investment net worth have returned, but all those “on sale” stocks you bought will get a super-charged boost and help you along even further! Win-Win!
So, in the end, what does this all mean for my own situation. Well, unless I take a good look at and reassessment of my current IPS, I think my best course of action is to keep doing what I’ve been doing. Every pay check, put whatever I’m able to into my current 80/20 asset allocation of ETFs, and keeping riding that market beast all the way to the bottom. And when that slide becomes a full force bull, well, that’s where the magic happens.
*If you don’t believe you can ride “up” slides, then you should go and check out Disney World’s Typhoon Lagoon’s Crush ‘N Gusher if you get the chance!
