Buy-and-Hold Beats Rush-and-Flush Investing During a Bear Market

I can be - and often am - as pessimistic as the next crabapple, but I happen to believe that a "buy-and-hold" approach is the way to go during a Bear Market. A mad rush to the exits - and flushing investments - simply and often needlessly adds to the downward plunge of the market. There's a better way. Since I’m not a credentialed financial advisor, the answers (observations) I give are strictly my opinion.

Defining the Bear

For the newbies among us, let’s define the term “Bear Market,” which is in the news so much these days. When markets decline 20% or more over a period of time…say a period of 60 days or more…the Bear is growling.

I personally measure my own exposure to Bear Markets by considering the collective percentage changes in stock prices of the Standard & Poor’s 500 (S&P 500), the Dow Jones Industrial Average (DJIA) and the Nasdaq Composite Index (Nasdaq) – the composition of most broad-based investor portfolios.

Buy-and-Hold Philosophy

I am a “buy-and-hold” investor and have experienced more than one extended Bear Market. It isn’t fun, but sitting out these difficult times (exercising patience) is an approach that has worked for me and I think that, collectively, it helps temper a large-scale sell-off in the market.

Admittedly, some folks have no choice but to sell (panic or not). Others have choices, but often still decide to rush for the exits. Still, more and more investors are hanging in there, and in my opinion, do help restrain the worst impulses of the market.

But human nature being what it is, the beat goes on. In short, Bear Markets will always be part of an investor’s future…as will the flushers among us. By the way, I’m not suggesting that markets never become overvalued from time to time. They do. But wouldn’t it be nice to experience an orderly correction rather than a stampede once in a while?

The COVID Bear

In my humble opinion, aside from recent political influences, the current Bear Market is a declining market largely inspired by a recent bubble, which resulted from the overvaluation of stock in recent years. There was also a short-term, quickly-correcting COVID-19 Bear Market in the early months of 2020 that was caused by a panicky overreaction to a completely unexpected and catastrophic event.

In March 2020, the DJIA went big-time Bearish for the first time in over a decade due to the impact of the COVID-19 pandemic. The S&P 500 and the Nasdaq followed along. All three quickly recovered, revealing that Bear Markets can occur in otherwise vigorous economic circumstances.

That blip was most certainly not due to declining profits, or a “normal” financial crisis in one industry that transits to others. A major “herd mentality” panic was the big driver of what took place in March 2020. And for those who decided to hang tough, it took both mental and monetary fortitude to ride out that brief storm. In all probability, the 2020 recovery happened quickly because many folks recalled the strong and booming economy in the months leading up to the pandemic…low unemployment…low inflation…low interest rates, etc.

The Current Bear

A major correction like today’s, once in play, can frighten potential investors away – a fear that, all by itself, can keep a Bear Market alive. Add to that is the lingering psychology of millions of herd-types who have already flushed their portfolios.

As I’ve been known to mention, being a member of the thundering herd exposes an investor to these potential negatives:

Hurriedly dumping an asset usually creates a real capital gain (an avoidable taxable event) or a real loss (not a paper one).
Too often, heading for the exits can infuse investors with a fear of markets such that some psychologically-wounded investors never return, or if they do it’s often after the market has substantially recovered (a big opportunity cost).

In short, not reentering a recovering market on a timely basis can be very expensive over the long term (and another reason not to be a market timer). Consider the risks.

It's Called FOMO

The Factset Chart below shows what happens to a “flusher” who missed the 10 single best days in the S&P 500 over the past 20 years. In those past 20 years, seven of those best days happened within two weeks of the 10 worst days - likely market correction bottoms. Why take a chance of missing those best days?

To put it in dollars and cents, the Factset Chart shows the annualized performance of a $10,000 investment made during the past two decades. If an individual had remained fully invested, the return would have been 9.4% or $60,253. If they missed the 10 best days, the return would drop to 5.21% or $27,604. If they missed the 20 best days, the return would plummet to 2.51% or $16,414. If they missed the 30 best days, ugh, it plunges even lower to 0.32% or $10,651.

The chart is indicative of good reasons to stay in the market and to NOT try to time it. Often the best and worst trading days occur close together. During this 20-year period, seven of the 10 best days occurred within 15 days of the 10 worst days. You have to stay invested, folks, or run the risk of missing those “best days,” and they’re few and far between.

This past week was a perfect example when stock prices surged the day of the Federal Reserve’s announcement of rate hikes followed by a dive the very next day. And during the first week of October, two of the best market surges occurred during what has been a rather grim and continuing market correction. If you weren’t in the market…well.

Two Bear Fundamentals

The value of personal investments in a Bear Market may drop suddenly or may deteriorate slowly over time. The end result is the same - your portfolio value suffers.

In my mind, a savvy investor should focus on two fundamental principles relative to Bear Markets…principles that avails one to take advantage of depressed market opportunities.

A Bear Market is bad only if you sell unnecessarily, or if you must sell out of necessity.
Depressed stock prices can be very good friends of the long-term investor.

Depressed Dollar-Cost Averaging

Depressed prices provide investors a great opportunity to make periodic, fixed-amount investments over time, which brings down the average unit cost of a portfolio. It also shortens an investor’s recovery period after the Bear attack. This phenomenon is commonly known as "dollar-cost averaging," or buying more shares when the price is down and fewer shares when the price moves up. It all adds up to owning more shares. A Bear Market creates a great opportunity to accelerate your returns…and your recovery…over the long haul.

The rote way to implement a dollar-cost averaging plan is through a dividend and/or capital gain reinvestment program. Those myriad reinvestments can reduce the cost basis of a portfolio by simply increasing the number of units in the portfolio purchased at a cheaper average price. This will enable a portfolio to reach break-even on the upside more quickly than would the original units.

In Sum

Patient investors…I call ‘em buy-and-hold investors…tend to use down markets as opportunities to acquire carefully-researched stock, frequently on a dollar-cost averaging basis. These investors tend to believe that markets in the short term are inefficient – often functions of emotion – and that a quality portfolio developed over time will be rewarded since quality companies are highly likely to regain reasonable valuations.

In short, buy low and sell high…always good advice if you can follow it.