Investors are often happy in bull markets and decidedly less so in bear markets. We almost instinctively view bull markets as positive while perceiving bear markets as negative. That impression has taught us to react emotionally to market ups and downs instead of logically, but that impression doesn’t necessarily hold up under scrutiny!
Reacting properly to the market, whether it’s bullish or bear-like, is vital. We must understand how to approach each in order to maximize our chances of securing a prosperous future.
Bear vs. Bull: What’s the difference?
Most people have heard the terms bull and bear markets, but beyond a basic understanding that one is going up and the other is going down, they haven’t considered the nuances of each. Understanding market conditions is key to determining your investment strategy. Opportunities and pitfalls abound in both bear and bull markets.
A bear market is one in which prices fall, causing stockholders to sell. Look at that definition carefully; it’s important! If investors sell during a bear market, they are selling at a lower price than the asset's original value. Buying high and selling low is the opposite of what you want todo if you intend to grow your money. If you sell assets when they are down, when the market rises again you have locked in your losses with no way to recover.
Despite their reputation, bear markets often represent opportunities! Asset prices have fallen, which may indicate that it’s a good time to buy more rather than sell what you have. In bear markets, it’s important to reassess your risk tolerance. You’ll often find it’s lower than you thought when the market was performing well. Once you understand how averse you are to risk, make sure your emotions are in check. Reacting emotionally to the market is often a recipe for losing money.
A bull market happens when asset prices are rising. There are better and worse ways to react to those as well. Bull markets encourage people to take on risk. They see prices rising and want to get in on the action. However, if you aren’t paying attention, you might buy at the top of the price range, which will make it harder to grow your investment.
Just as you would in a bear market, assess your risk tolerance when the market’s bullish. It’s easy to think you have a high risk tolerance when the market is soaring and making money seems easy. But think carefully about what your reaction would be if the market were to turn downward. Would you be comfortable staying in your position, or would you likely decide your position was too risky and jump ship? If you’re more likely to lean toward the latter, you maybe exposing yourself to too much risk based on your personal risk tolerance.
Avoid Relying on Labels
Regardless of how the market is labeled, bear or bull, it’s important to react to its actual conditions. Because it’s impossible to predict the future, status declarations always come after the market has already changed. A great example happened recently in the cryptocurrency market.
New investors bought cryptocurrency when its value soared to more than $60,000. Not long after, the market crashed and the value of cryptocurrency plummeted to around $20,000. News stories highlighting the cryptocurrency downturn came after investors had already lost fortunes.
No one can predict the future, but you can hedge your bets by considering multiple perspectives. In our office, we have several money managers rather than just one. We know that no single person will be right all the time.
Even the best money manager on the planet won’t have a 100% accuracy rate. By diversifying perspectives, we can react rationally instead of emotionally. It’s important not to have all your eggs in one money-manager basket.
At Asset Preservation Wealth & Tax, we routinely help our clients avoid making emotional decisions that could cause them to lose money. Whether bear or bull, the market is a constantly-changing situation that often defies labels. When things look good, try not to get overconfident. Conversely, when they look bad, don’t panic. Both of these stances can be very difficult to adhere to, which is why you should use a financial planner as an accountability measure.
Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.