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Déjà Vu All Over Again - Part 3

Déjà Vu All Over Again - Part 3

| July 20, 2022
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Last week we started to talk about what you can do, as a long-term investor, to weather the bear, specifically the merits of avoiding panic and emotional responses. This week we are going to talk about two smart strategies you can employ in a bear market.

Dollar-Cost Averaging

If you regularly invest a set amount of money in stocks, through your retirement plan, for example, you will end up buying shares with the same amount of money as market prices go down and less as they go up. This tilts the odds modestly in your favor. Probably the best part about dollar-cost averaging is that it is completely effortless, it just happens naturally as the market fluctuates. And, the benefits accrue on top of your regular contributions. Think about your 401(k) plan, contributions and employer matches typically account for two-thirds of the annual balance increase while investment gains make up one-third.1 That suggests many 401(k) contributors have the means to rebuild their account balances from bear markets relatively quickly.

Many, of course, does not mean all, and averages can obscure significant differences based on the size of the 401(k) balance, among other factors. As an example, those with balances of more than $200,000 experienced losses of more than 25% in 2008, while account balances under $10,000 grew 40% as contributions swamped investment losses, according to one study.2

Calibrate Risk

No amount of dollar-cost averaging can get around the fact that those with higher account balances have much more to lose in a bear market. Unfortunately, those larger balances often belong to those of us closer to retirement which means we have less time to make up any losses before retirement. 

Considering the balance of risk and reward, an investor approaching retirement should have a much more conservative approach to a bear market than a younger worker with a smaller account balance. Yet often that isn't the case. As of Q3 2021, Baby Boomers (those born between 1946 and 1964) were the generation most likely to be invested too aggressively, according to Fidelity Investments' study of its retirement plan participants. In contrast, 51% of the GenX plan participants, 70% of the Millennials, and 85% of GenZ were 100% invested in a target-date fund.3

Note too that target-date funds also risk big losses in a bear market, losing between 23% and 39% in 2008 depending on the target date.4

At the end of the day, only you, with the help of your advisor, can determine what portfolio allocation will let you sleep soundly and safeguard your future considering your age, means, and risk tolerance. The important thing is to figure it out and act accordingly instead of surrendering to inertia, or even worse, panic.

Next week we will finish out our discussion of smart things to do during a bear market by talking about diversification.

Until next time…

One last thought, I believe an educated investor is an empowered investor. If you like what you’ve read and think your friends and family can benefit as well, please share. 

Sources:

1 CNBC. "Fidelity: 401(k) Balances Little Changed Over 2011."

2 National Library of Medicine. "The Impact of the Recent Financial Crisis on 401(k) Account Balances."

3 Fidelity Investments. "Building Financial Futures," Page 9.

4 CNBC. "These 401(k) Funds Took a Beating in 2008 — And It Could Happen Again."

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

Dollar cost averaging involves continuous investment in securities regardless of fluctuation in price levels of such securities. An investor should consider their ability to continue purchasing through fluctuating price levels. Such a plan does not assure a profit and does not protect against loss in declining markets.

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