Bear Market! What (If Anything) Should You Do? – The White Coat Investor – Investing & Personal Finance for Doctors

[Update just prior to publication: I’m trying to get you guys some up to date content, I really am. I literally just wrote this a few days ago. Of course, in the last three days the market has climbed 20%, which according to the WSJ, actually marks the END of a bear market. Nonetheless, chances are good that markets will continue to be highly volatile for at least a while and there are likely to be more big drops as the market tries to figure it all out. So hopefully the post is still useful. Otherwise, I’ll just trot it back out in 2 or 3 years when we hit the next bear market. Stay safe out there!]

I have written many posts about bear markets over the years. Here is a brief sample:

We either have, or will be republishing most of those soon. However, given this is the biggest bear market since 2008 (and perhaps even bigger by the time all is said and done) it seems appropriate to write something new for you on the subject. So I thought I’d write a comprehensive post about bear markets, what you should do during them, and what you should not do during them. I’ll include some CoronaBear specific information as well.

General Bear Market Advice

Let’s start with some general bear market advice. This stuff pretty much applies to any bear market.

# 1 Stay the Course

I’ve been telling people for years to get a written investing plan in place. I wasn’t kidding. One of the best reasons to have a written investing plan is that when you have a question about what you should do with your investments, you simply have to go to the plan to remind yourself of what you are supposed to do. A good investing plan should have addressed what you would do in the event of a bear market. Historically, a bear market (20%+ drop in stocks) occurs about once every three years. It is an expected event. If you have a 30 year career and live 30 years in retirement, you will be an investor for 60 years and should expect to pass through about 20 bear markets. Bear markets are expected events; you shouldn’t be surprised by them. Your plan needs to take them into account. You need a plan that is likely to be successful under a wide variety of future economic possibilities. My particular investing plan (you know the one we drafted when I was a resident that made us financially independent multi-millionaires) gives us this instruction about bear markets:

Investing Personal Statement for Jim and Katie Dahle                   Revised 29 July 2007

….We will not panic and sell securities due to market corrections…We will rebalance our asset allocation as frequently as necessary using the 5/25 rule using new investment money as much as possible….Any significant changes to this IPS require a three month waiting period for reconsideration….

There you go. If I ever wonder what I’m supposed to do when the market 10-90%, I can go back and read this statement and remember that I’m not going to sell due to market corrections. In fact, it says we’re going to buy during market drops in order to rebalance our portfolio.

It seems a good time to drag out this classic Jack Bogle quote:

I’ve said “Stay the course” a thousand times, and I meant it every time.

Want to learn more about staying the course or about getting a written plan in place? Check out these posts:

# 2 Rebalance Your Portfolio

Rebalancing doesn’t necessarily boost returns in the long run (because you’re usually swapping higher returning stocks for lower returning bonds), but it does ensure that you maintain the risk of your portfolio at the level you originally selected. There are lots of ways to do it, but the most common ways are to do it on the same date every year or to do it when the portfolio deviates significantly from its specified asset allocation. The best part about rebalancing your portfolio is it forces you to sell high and buy low. If you feel a need to DO SOMETHING during this bear market, this is probably the best thing for you to do. Your written investing plan will tell you how to do this. More posts on rebalancing here:

# 3 Tax Loss Harvest

I just covered this in detail earlier this week, but this is a great way to make lemons out of lemonade. Essentially, in a taxable account you get to share your losses with Uncle Sam. You can book a taxable loss that you can use to offset an unlimited amount of capital gains and up to $3,000 in ordinary income per year by exchanging one investment for a similar but not “substantially identical” one. You’re not selling low, because you’re still fully invested in the market. More details at the following posts:

# 4 Make Sure You Have Enough Cash

Bear markets are often accompanied by recessions and recessions are often accompanied by job loss or decreased income. In those situations, cash can be very useful to keep you from having to raid assets that have temporarily decreased in value. In essence, it keeps you from selling your stocks low and your real estate at fire sale prices. An emergency fund typically consists of 3-6 months of expenses in easily accessible cash. Don’t be tempted to use that money to “buy stocks on sale.” Make sure you know what you really need. If you have more than that, feel free to invest it, but don’t put your emergency fund in stocks. The market can always fall further. Cash is king, but it is limited. Use it wisely.

# 5 Reassess your Risk Tolerance

I often tell young investors to dial back their proposed asset allocation until they go through their first big bear market. Well, now you’re in your first big bear market. Pay attention to how you feel about losing real money you used to have–money you invested instead of spending on a kitchen renovation, trip to Paris, or a Tesla. Sleeping okay? If so, then you can dial up the risk in your portfolio a bit, but do it at the end of the bear market (the market can always fall further). If you’re nervous about your investments and aren’t sleeping okay, aren’t you glad you took my advice? If you’re a psychological basketcase with these losses, don’t sell everything. Sell down to your sleeping point and STAY THERE going forward. Congratulations! You’ve found your risk tolerance. Unfortunately, it cost you some money to do so.

# 6 Don’t Look

Most of us are pretty good at ignoring our investment accounts for weeks or even months at a time. That’s probably a good thing. It becomes harder to do when the headlines are talking about massive stock losses. Your risk tolerance is probably higher if you simply avoid looking at your accounts during these times. Shred your mailed statements without taking them out of the envelope. Get yourself locked out of your online login. Whatever it takes. Just stay the course.

Pandemic Specific Advice

Every bear market is unique, and this one is no different. But they all end the same way and I assure you, they all end. If it doesn’t end, it really doesn’t matter what you do with your investments anyway because you’ll be in a post-apocalyptic scenario. There are a few interesting aspects of this one that are worth spending a few minutes on though.

# 1 Your Mortality is Higher

The first is a bit macabre to discuss. But health care providers like many of the high income professionals who read this blog are more likely to get coronavirus. Many of them are middle age or older and have higher risk of dying from it than younger people. Most of the doctors I have talked to feel like soldiers going into a war zone every time they go to work these days. There are a few financial planning considerations that you may not have taken care of. I hope the new terror inherent in your daily work will provide enough motivation to do so. These include:

1. Get disability insurance (unless financially independent)
2. Get term life insurance (if anyone else depends on your income)
3. Get a will in place
4. Do any other needed estate planning tasks

# 2 Your Income is Lower

As a general rule, doctors tend to have a very recession-proof business. People get sick and injured at about the same rate whether economic times are good or bad and they often use a third-party payor to pay for your services. However, in this particular pandemic, almost all dentists and many physicians are sheltering at home along with everybody else. Even those still working are doing it by phone and video, and getting paid less if at all. Emergency department volumes have also dropped as patients are told to stay away from the hospitals.

Luckily, your spending is almost surely down as well since restaurants, movie theaters, concerts, plays, school functions, and especially vacations have all gone away. However, unlike most bear markets, you may not have the money to make your regular investments, much less invest a little extra to buy stocks on sale. You might consider other income boosting activities, like taking surveys or doing telehealth to partially make up your losses. It’s not a bad time to start a work from home side gig either, although many of those (like blogs and podcasts) probably won’t generate any income before you’re back at work.

# 3 You Have More Time

Since you are likely working less than usual, you have a lot more time. We are enjoying the “reset” with our kids and being able to spend more time with them. Another great use of this pause in your life is to finally become financially literate and get a written financial plan in place.

You have time to read some good books, take an online course, or work with a financial planner via videoconference to do so. You also now have time to review your insurance, review your estate plan, rebalance your accounts, refinance your mortgage, refinance your student loans (at least apply and lock in the rate, even if you wait until the short-term 0%/no payment thing ends), or get advice on your student loans.

Take Advantage of Bear Market Opportunities

# 1 Buy Stuff

If you are in the fortunate situation to have steady work/income and plenty of cash on hand, this can be a great time to buy something you have been waiting to buy. There are likely not very many people out home shopping these days and stores are awfully empty. Those small business owners (and the overall economy) will be very grateful to serve you. Obviously you need to follow appropriate public health guidelines, but recessions are often a time to score a great deal on all kinds of stuff. The car I’m still driving was purchased in January 2009. We got a heck of a deal because we were the only ones buying at the time. Same thing when we bought our house in Fall 2010. We looked at 30+ houses and 6 months later when I checked the only one that had come off the market was the one we bought.

# 2 Buy Stocks Instead of Stuff

Okay, this will sound weird given the opportunity above, but a bear market can be a great time to delay purchases. If you put that house, car, renovation, vacation or whatever off for another year or two, you can use the money you had saved up for it to buy stocks on sale. Shelby Davis said, “You make most of your money in a bear market, you just don’t realize it at the time.”

# 3 Get Rid of Legacy Holdings

Some people are stuck with “legacy holdings” in their portfolio from a time when they were not so financially literate. These are usually individual stocks or actively managed funds. Once they became knowledgeable, they decided to just hold on to these investments due to the massive tax hit they would take if they sold them and had to pay the long term capital gains taxes.  They may have built their portfolio around them rather than using investments they preferred, typically low-cost, broadly diversified index funds. Well, when the market fell, the tax cost of swapping these investments for something you actually want just went down and may even go away completely. Why not build the portfolio you really want if it doesn’t cost you anything to do so?

# 4 OverRebalance

Some people have put a provision into their written investing plan that permits them to overrebalance. This could be considered a form of market timing or tactical asset allocation and it takes rather high-risk tolerance, so it is hard to recommend for most. But done well, it can be very profitable. Basically, the way it works is as follows:

Let’s say your portfolio is normally 60/40 stocks to bonds. Perhaps if the market falls 20%, you adjust the portfolio to 70/30. So you are not only rebalancing, you are Overrebalancing. Then if it falls 40%, you adjust to 80/20. If it falls 60%, you adjust to 90/10. Make sure your written plan specifies how you will reverse this on the other side of the bear market. The big downside of this approach occurs in an apocalyptic scenario where you rebalance the portfolio right down to nothing, but honestly, if the stock market goes to zero I wouldn’t expect much from your bonds.

# 5 Roth Conversions

When you move money from a tax-deferred account to a tax-free (Roth account), this is called a Roth conversion. You are essentially prepaying the taxes you would pay when you pulled that money out of your tax-deferred account in retirement in hopes that it will lower your overall tax rate on that money. However, after a market crash your tax-deferred account is smaller and so converting the same number of shares to a Roth account will cost you less money. Thus, if you were planning to do a Roth conversion anyway, a bear market is a great time to do it. As a general rule, you want to pay the tax bill for the conversion out of taxable assets, not the tax-deferred account itself. This has the effect of moving money from a taxable and unprotected account to a tax-protected and asset protected account.

# 6 Reduce Your Estate Taxes

If you have an estate tax problem, one of the best ways to lower it is to do periodic gifts of $15,000 per person per year to your heirs. It also helps to give assets away (via an irrevocable trust, annuity, family limited partnership, or family limited liability company) before they appreciate. When assets are worth less (i.e. in a bear market), you use up less of your estate tax exemption making these > $15,000 gifts.

An example might be a Grantor Retained Annuity Trust (GRAT). This is an irrevocable trust where the grantor (rich old dude) puts money into the trust and then gets payments from the trust to live on for a specified number of years. After those years are up, the beneficiary (young poor dude) gets whatever is left (usually the principal). Because the beneficiary doesn’t get the money immediately, it isn’t worth as much so the gift uses up less of the estate tax exemption than it will eventually be worth. When stocks are down, they can be put in the GRAT and all that appreciation will go to the beneficiary without reducing the estate tax exemption. A Grantor Retained UniTrust (GRUT) works similarly, except the beneficiary gets the payments and the grantor gets the principal at the end.

The principle is basically the opposite of giving to charity. You want to give more to charity when stocks are appreciated since you get a bigger tax deduction for it. But any time some of the money goes to your heirs (including some types of charitable trusts), you may be better off doing it in a bear market than a bull market.

Things You Don’t Want to Do in a Bear Market

Finally, we should go through a bunch of things you will probably be tempted to do in a bear market, but shouldn’t.

# 1 Time the Market

It is so tempting when the market is going up or down by 5 or 10% a day. Don’t do it. You’re an investor, not a trader. These are assets you are buying for the next 30 years, not the next 30 minutes. Follow your written investing plan.

# 2 Day Trading

Ditto.

# 3 Buy Individual Stocks

It is no smarter in a bear market than in a bull market. You don’t know if an airline, cruise ship, or oil stock is just temporarily beaten down or if it is on its way to bankruptcy. Just buy them all and hold them forever.

# 4 Buy Actively Managed Mutual Funds

If the fund managers had a functioning crystal ball, why didn’t they sell all their stocks at the market high? Active managers are no better at picking stocks in a bear market than in a bull market. They are unlikely to do it well enough to overcome the costs of doing so in the long run. They do usually have a bit more cash in the fund than an index fund, but that will just hurt them more in the recovery (and most of the time.)

# 5 Buy Leveraged Inverse ETFs

Buying a fund that bets against the long term direction of the markets is a fool’s game  and requires a functioning crystal ball to do well in the long run. Adding leverage just makes it all worse. Avoid leveraged ETFs of any kind, especially in a bear market. They are not tools for long-term investors, which you should be with your serious money.

# 6 Short the Market

Here’s another frequent temptation in a bear market- to short the market. When you short a stock, ETF, or fund, you first sell it, then you later buy it. I know, it sounds a little weird, but that’s how it works. The idea is that if the market falls in between the time you sell it and the time you later buy it, you were able to sell high and buy low. You actually have to borrow the securities in order to sell them and lending them is a significant source of revenue to index funds. Needless to say, there is a cost to borrowing them and again, you’re betting against the long term direction of the market while trying to time it. It’s a recipe for disaster. You’re probably better off at the roulette table.

# 7 Buy Puts

If shorting the market isn’t adventurous enough for you, you can also bet against the market using options, specifically put options. When you buy a put option, you do so at a specific price (the strike price) for the security (stock or ETF). If the price of the security falls below the strike price, you can “put” it to the seller of that option at the strike price. Your profit is then the difference between the current price and the strike price, minus any associated costs. However, when you buy an option, it is usually for multiple shares. So spending $2,000 on a successful put option in a nasty bear market might make you $10,000 or more. Or, if the security never goes below the strike price, the option might expire worthless for a complete loss of your investment.

These extreme outcomes are more akin to gambling than long-term investing and should thus be avoided by the long-term investor with their serious money. Expect that anyone selling you a put option is far more knowledgeable about that security than you are. If shorting the market is like playing roulette, buying puts is akin to borrowing money from a payday lender to enter the world series of poker.

# 8 Leave the Stock Market for “Alternatives”

Anytime the stock market turns down, people come out of the woodwork to say “I told you so.” It doesn’t matter what they were selling beforehand, they will point out that it didn’t just drop 20-40% in value. You’ll hear this from anyone from Bitcoin promoters to trend followers to whole life insurance salesmen. But just like you never hear from the anti-vaxxers during a pandemic, you’ll never hear from these folks when stocks are doing well, which they usually are. Their cries are annoying, but these alternatives can be safely ignored as you follow your written financial plan. If you were convinced of the long-term merits of owning shares in the world’s most profitable corporations (publicly traded stocks) before the bear market, there is no reason to change your mind now that those shares can be purchased at a lower price.

I hope these tips will help you come out on the other side of the bear market smelling like a rose. This too shall pass.

What do you think? What other bear market advice do you have for new and experienced investors? Comment below!