Learning to welcome the bear

A couple of relatives whom I love very much have decided to open a self-directed investment account. Prior to this, their RRSP savings were kept in mutual funds. To them the mutual funds felt safe, even conservative, let us be clear -- that money was in the market. A self-directed portfolio is not as big a step as most folk believe.

I worry about them and this decision. Why? Because this decision will make them aware of the daily vagaries of the market. With mutual funds, one sticks the money in and walks away. With a self-directed portfolio one tends to keep an eye on what the market is doing and if one is not prepared for the all too common retreats from recent highs, panic can set in. I know a lot of people who have put money into the market, panicked when the market dropped and got out of the market with whatever funds remained. 

So, I believe anyone getting into the market should know what they are getting into. To that end I have some links I would like to share:

Historical stock market data (Canada): One important take away from this post is the fact that, generally speaking, markets spend more time making money than losing it.

• The Canadian market has been positive 73.7% of the time
• The Canadian market has been negative 26.3% of the time

Looking at this another way, investors who buy and hold have a probability of making money 73.7% of the time. Investors trying to time the market must be right more than 73.7% of the time to do better than the buy and hold strategy. That’s a high bar to clear.

When I retired in 2009 the financial wizards on the financial beat at the newspaper where I worked warned me not to put my buyout money into the market. I did. Where they saw disaster, I saw opportunity. I was right; they were wrong. Read what Jim Yih wrote on his blog:

Markets tend to rebound after bad years. The TSX has experienced back-to-back negative years only twice over the past 75 years.

• The TSX was negative in only 20 out of 79 calendar years.
• In 18 of those 20 years, the market bounced back with positive returns in the following calendar year.
• The average return in years following a negative year has been 14.6%.
• Internationally the data is very similar but there has been a little more volatility and also greater downside risk.

Now, let us turn to Investopedia, an excellent source for facts related to investing. Here is a link to the page I am referencing: 3 Reasons to Not Sell After a Market Downturn. 

The average duration of a bear market is 1.4 years, compared with 9.1 years for the average bull market. The average decline of a bear market is 41%, while the average gain of a bull market is 480%.

Folks often talk about the risk of losing money in the market. A much bigger risk is getting out of the market and missing the recovery, missing the next 480% gain in the market. The past is not a perfect predictor of the future but it does provide some assurances that what goes down tends to go up in the end. To be a success in the market, one needs to be positive. Instead of selling on the way down, try buying instead. That is what I do.

One is often warned that this advice does not apply to those close to retirement and who do not have the luxury of time to ride out periods of market volatility. These retirees and soon-to-be-retirees should have more conservative portfolios.

This is true for those who might be forced by circumstances to sell during a market downturn. But then no one should be in the market who does not have the ability to ride out a market retreat, correction or bear market.

I have invested mainly in dividend paying equities both before and during retirement. My dividend income is higher than absolutely necessary to live. In other words, I could suffer a decline in my dividend income and, with some jiggling of numbers, I could still balance my books. 

In a truly severe bear market, I expect I might suffer a decline in dividend income of up to as much as 15%. I can handle that. And during a truly severe bear market, I will pick up some very good stocks at bargain basement prices. Owning these stocks will boost my dividend income. In other words, done correctly, retirees can welcome the bear and benefit from the crashing market.