Coping Skills for a Bear Market

“These recent events offer a ringing endorsement of broad diversification and a consistent portfolio strategy as the best way to deal with uncertainty.” – Weston J. Wellington.

Ron Lieber writes the Your Money column for The New York Times. His beat covers everything from credit cards, student loans, frequent flier miles, paying bills online to tips on negotiating the buying of a house.

Lately, he has written two interesting columns on investing during a Bear Market.

On September 13th, he wrote Memo to the Uneasy Investor: Be Strong.

He argued against the temptation “to climb under the covers, money safely in the mattress, and hide from a world that has surely changed forever.”

He recognizes that our psychological makeup may not be suitable to successful investing.

Your natural inclination is probably to sell everything and invest in certificates of deposit or throw the proceeds in a money market fund. In fact, evolution insists on these feelings.

“We had survival mechanisms built in to avoid sitting around debating whether we should run away from the saber-toothed tiger,” Mr. Benningfield said. “That’s the fundamental problem with long-term investing. Our skills aren’t really that transferable to the challenges involved.”

But he counsels being brave and following your plan.

Investing in the middle of market gyrations isn’t just a question of controlling the urge to sell indiscriminately. It’s also about taking a close look at the contents of your portfolio and then forcing yourself to fix an asset allocation that is out of whack and to buy in sectors of the markets that are out of favor.

On September 27th Lieber delved into psychology more fully in The Financial Adviser as Hand-Holder. He interviewed “financial planners and investment advisers who got their start as psychologists or studied the field as graduate students, plus a few ringers who are adept observers of minds and money, even though they have formal training only in the latter.”

I asked them this: At this troubling moment, what’s the best way to reorient how we think about money, before we make any rash decisions about what to do with whatever we have left?

Their conclusions include “the markets will eventually recover” and “We have time on our sides.”

Managing our money is a process that unfolds over decades, not days. It’s easy to forget that, when one company after another is falling victim, week after week, and we can track their disintegration on an hourly basis.

“I think reminding people in this environment of why we’ve chosen the investment strategy that we have is a good thing for those who are a little bit antsy,” said Constance Barber, a certified financial planner with Barber Financial in Natick, Mass., who got her start as a school psychologist. “We’ve usually not set this up because it’s money that you’ll need tomorrow.”

Even if we don’t need the money right now, it doesn’t feel good to look at a retirement portfolio and find that it’s down 15 percent from its peak a year ago.

“People rely on selective memory when they’re only looking at losses from the high point that the portfolio reached,” said Victoria Collins, who has a Ph.D. in social psychology from the University of California, Berkeley and has worked as a certified financial planner for more than two decades.

This was a point echoed by many people I spoke with this week. On one hand, it’s certainly depressing to be down to $340,000 from $400,000, for instance. The basic math doesn’t help the mood either, given that after a decline of 15 percent, a portfolio needs to gain 17.6 percent just to get back to $400,000 again.

We can mimic that mindset if we choose, or we can consider what our balance was, say, a decade ago. Chances are we’ve made a lot of progress since then, if we’ve been saving all along. “There are clients who will say, ‘Yes, it’s down, but look where I started,’ ” said Ms. Barber, the former school psychologist. “ ‘I’m hanging in there, and we’ve come a long way, baby, and it’s O.K. for now.’ ”

One tricky part about the last several weeks is confronting all the headlines declaring this the worst financial crisis since the 1930s. “Most of the individuals that I find who need more handholding are the ones who’ve had some connection with the Great Depression,” says Ms. Collins, the Berkeley Ph.D., who is now an executive vice president and principal with Keller Group Investment Management in Irvine, Calif.

These people tend to be retirees, who may have had parents who told them stories about living through the 1930s or are old enough to remember it themselves. If they have little or no earning capacity now, they feel especially helpless when they see parts of their portfolios disappearing.

“I try to remind them that even they don’t need all of that portfolio today,” she said. “You’re only withdrawing a certain amount.”

Ms. Rich suggested that people reach out to someone else to discuss their situation if they don’t have a hybrid financial adviser-shrink to counsel them through the crisis. It could be a peer, a family member, a member of the clergy or staff at a senior center.

My Perspective

Bear Markets are neither unusual nor unexpected. Depending on exactly how you count, we have had 13 Bear Markets since World War II.

Repeat after me, “Bear Markets happen.” Stock prices fluctuate. Risk shows up at unexpected times.

If you cannot accept that, you might consider keeping your money in CDs. But if you follow that strategy, you have little chance of earning a decent return. In fact, after taxes and after inflation, you may achieve a negative return. Your strategy may appear to be less risky, but, in my opinion, you are fooling yourself.

Over the long term, taking on acceptable risk through a diversified portfolio of stocks, bonds, money market funds and other investments will pay off in higher returns. If you had ignored all of the Bear Markets since World War II and had kept fully invested in such a portfolio, you would be way ahead of someone who followed a very conservative approach.

For a discussion of why we should accept Bear Markets see my earlier post.

photo credit: mitchgibis