Investing

Three consequences of selling in a bear market

According to an article on BrighterLife.ca by Kevin Press, the bear market is officially here. Markets have fallen over 3000 points from their peak in March and all the gains in the first quarter of the year are gone and then some.

It’s times like these that investors contemplate selling and getting out of the markets. In recent weeks, I’ve talked to a number of investors who are just fed up with markets and mutual funds. And really, who can blame them? Investors have been told for quite some time that over the long term, markets will do better than fixed-income investments like bonds or GICs. Unfortunately, that just has not happened. The markets have not had a stellar track record over the past 10 years.

Despite the tough numbers, investors looking to sell today need to understand three really important consequences to selling today:

1. Crystallizing losses and selling low.

We all know the theory to make money in the stock markets – Buy Low, Sell High. Although that makes logical sense, it’s tough to do because times like these when prices are low (20% lower than a few months ago), our gut instinct and emotion tells us to do the opposite.

I’m sure you’ve heard advisors tell you it’s the wrong time to sell. The old strategy of buy and hold says it’s important to have patience and hold and just get through these tough times because eventually, prices will come back up. If you sell, you only crystallize the losses. If you don’t sell, the losses are just paper losses. I hate to say it but there is definitely truth to this. The consequence of selling is the crystallization of losses and the likelihood of selling low.

2. What’s the alternative?

So let’s say you sell. Now what? Where are you going to go? Cash is paying you nothing. Interest rates are low so GIC rates pay very little. Bond yields are not much better and carry downside risk if interest rates rise. Will real estate, gold, silver commodities do any better? There’s no guarantee and really the risk of future drops is still there.

One of the consequences of selling today is there just is not a lot of places to go. If you sell at a 20% loss and move to a 2% guaranteed return, it will take 12 years to get back to your original value before losing 20%. Chances are the markets that will make back that drop long before those 12 years. I’ve always been a big fan of GICs but selling to these low returns is not logical.

3. When to get back in?

Some investors argue that they just want to get out ‘for a while’ until things stabilize. I can tell you from my 20 years of experience, this is a losing argument. This is a form of market timing and market timing consistently is impossible. We’ve all heard tales of market timing luck but consistent predictions of future market movements are impossible.

The other problem is psychology works against you. Linear extrapolation is a phenomenon where we, as investors, can’t help but think in straight lines. When something is going up, we think it’s going to keep going up. When something is going down, we think it’s going to keep going down. Look at a market chart over the last day, week, month, year, decade, etc. The markets have never moved in a straight line and never will! The reality is marketing always moves in cycles. Your gut and emotions will lead you back in once a recovery have started and data suggests that you may miss out on the best returns of the markets.

Don’t fall into this trap. The consequence is too severe.

My two cents

If you are planning to sell, this article is the last thing you want to hear but tough times require tough discipline. Before you sell, take some time and really think about it. Try to be as logical as you can. It will be tough but irrational behavior make create damage that is tough to repair. If you really want to get out, the time to do it is after the recovery is well underway and mark my words it will come. I just can’t tell you when it’s going to happen. But maybe by then, your emotions will lead you to a sense of confidence that because things are going up, they will continue to go up. And then we’ll revisit this cycle again!

Comments

  1. Brian Donaldson

    First the bear market started in 2000 and will last 17 to 20 years. The general public will always get it wrong because they listen to perm bull media and advisers. In the last run up in Gold who was writing articles to sell gold at $1920. Nobody everyone was trying to figure out a way to get in at the highs. The general public has no clue how to trade stocks and commodities. Please write Buy low and sell high to Buy High and Sell even higher. I have watch this play out so many times in the last 4 years it’s now even funny anymore. For disclosure I am long USD and short-term bonds. I am short commodities and stocks.

    • Jim Yih

      Thanks for your two cents Donald. I’ve heard buy high and sell higher too but that strategy bears risk as well. My preference is to buy and rebalance periodically. Anyone else want to share their winning strategies and philosophies?
      Jim

      • BC_Doc

        I would agree with Brian that we are deep into a cyclical bear market– the last time the I remember economic pessimism this pervasive, Americans had hostages being held in Tehran and Ronald Reagan was on his way into the White House. If Brian is right, after the huge run-up in stock markets during the 80s and 90s, we probably have a few more years of unwinding to come.

        My winning strategy? I hope it’s a winning strategy– time will tell! I’ve gone with global capitalization weighting– 41% US, 59% rest of the world using Vanguard ETFs (VTI-N and VEU-N). Both products are very low-cost (MER of 0.07% and 0.22%). I can’t predict whether the US will recover its “star” status or if another country will emerge as the economic powerhouse of the 21st century– global cap weighting seems like the best hedge to me. Finally, I’ve tried to buy on the dips– late 2008, early 2009, now– and will hold until retirement. Thanks!

        • Brian Donaldson

          The biggest problem in this bear market is most people don’t have a plan in place. Here is what most people’s plan look like. Hand money over to some company or bank let them buy a lot of different stock thru a fund and hope it goes higher. No Stop Loss (Risk management), no hedging (Options & Futures Contracts), no Sell Target (Profit Taking), and no short Selling when stocks fall in price. The professional trader does why doesn’t the retail trader??? Education is the problem.

  2. Steve

    Also keep in mind that diversification still works. The truth is, for all the doom and gloom in the media, the S & P 500 is down less than seven per cent on the year, compared to Europe. Canadian REITS are for the third year in a row. Diversification works

    • Brian Donaldson

      Warren Buffett, one of the world’s greatest investors, said, “Diversification is a protection against ignorance. It makes very little sense for those who know what they are doing.
      Source http://finance.yahoo.com/personal-finance/

      • Jim Yih

        I think diversification makes sense as it is protection against being wrong and everyone is wrong at times when it comes to investing. That being said diversification is an abused term. There is a difference between planned, intentional and logical diversification versus blind diversification or some have said di-worsification

  3. Chris Hecker

    > The consequence is too severe.

    > Some investors argue that they just want to get out ‘for a while’ until things stabilize. I can tell you from my 20 years of experience, this is a losing argument.

    If you look at the broader history of markets — that is, broaden the scope to more than just European and North American economies since WWII — the strategy of “it’s important to have patience and hold and just get through these tough times because eventually prices will come back up” falls apart over really long time frames.

    To use an overwrought example, if someone retired in 1929, the correct investment decision would have been to sell out once stocks bounced back in 1930. Or, take the example of the Nikkei since 1990. Or the South Sea scandal, or the Dutch Tulip Mania. In all these cases, investors who held through a bear market waited multiple decades for prices to rise again to the same levels. Many would have died in penury.

    Until markets break out of the secular bear market that started in 2001, we don’t know what the eventual lows will be, or how long it will take to recover even to today’s depressed levels.

    A more honest analysis says that we can’t predict history, and that an investor shouldn’t risk money in the markets that they can’t do without for at least 10 years.

    I’m with Todd Harrison when he says that Capital Preservation is the most important factor in the current environment of debt deleveraging.

    • Jim Yih

      Chris, thanks for the perspective (and the history lesson). One thing we both agree on is we don’t know what the future holds. The market has the same chance bouncing back overnight as it does dropping another 20%.

      I’ve always said, we can use historical data to prove any point we want. It’s the future we can’t predict.

  4. Ken

    Wrong! get out when the markets go just below their 200 day moving average. Get back in when it goes above.

  5. 20's Finances

    I agree that people should reconsider getting out of the market at this moment. If anything, people should consider buying into the market. It is almost guaranteed to bounce back. Historically it always has rebounded.

    • Jim Yih

      I like the idea of buying but I think systematic buying or dollar cost averaging is the best way to buy all the time. It takes the timing guess out of it.

      Thanks for your comment!

  6. Financial Independence

    What you can do, is to get out of the marker, waiting it being grounded and come back then.

    Alternatively invest in something else, such as precisious metals, properties, etc..

    There is many things yuo can do. Some of us do not have another 20 years to recover..

    • Todd Boyd

      People without 20yrs to recover also shouldnt have a 100% stock portfolio. Cash wedge?

  7. Bruce

    I tend to like Van Tharp’s idea of position sizing with a stop loss equal to 1% of the total portfolio, but I’ve only been trying it for the last few months. I’m also trying to add trailing stops and selling covered calls to get out with a profit before things drop like the gold example. I’ve also ended up selling my stock position but retaining the short call until it expires worthless.
    You might want to suggest people sell a covered call instead of selling out of fear. It might make it easier to hold the stock, by hedging their position…

  8. youngandthrifty

    Buy when others are fearful and sell when others are confident 🙂

    Great post Jim!

  9. Bryan

    I agree with the general idea of selling during bear markets is poor strategy. However, I believe what matters most is what point we are at in the bear market. Historically the P/E of the S&P 500 has a median (and mean) of 16. Currently, the S&P P/E is 19.66. If you’re a value investor this does not scream buy buy buy. The S&P was in the 14-16 range during the market bottom in 2009.

    The current VIX levels demonstrate that you can “lose your shirt” if you’re bull outlook is wrong.

    If you were to ask me if I would be buying, or selling, I’d be selling ALL stocks that don’t show a history of paying increasing dividends. The devaluation of the EURO and USD is troubling and with the actual unemployment rate hovering at 23% since 2009 (shadowstats.com) I don’t see any hope in sight for at least the next 5 years.

  10. Tara

    I am going to continue dollar cost averaging into my 401K with a set of low-cost index funds and sit tight for the next 20 years until retirement.

  11. Kanwal Sarai @ Simply Investing

    Great post Jim! It always surprises me how many people will buy when stock prices are rising and sell when prices drop. You incur losses or gains when you sell, and if you sell low….well then you’ve solidified your loss.

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