The Opportunity of Bear Markets

Space CapsulePeople are funny when it comes to investing.  If they were to go into a store and see a rack of slacks half off the normal price, they would pick of two or three pairs because it was such a great deal.  If they look at their stock portfolio and see that some of the stocks they own are down 50%, they pull their money out to wait for things to settle down.

Really, most of the time is only a decent time to invest.  During these times stocks may still have a ways to go before the next decline, but you might only be able to eek out a 10-20% gain during the year.  Right after a good bear market, however, great stocks may be down 50-70% or more.  That provides what could be the buying opportunity of the decade since those stocks may go up 400% over the next year or so.  Just take a look at the crash of 2008 and see how many stocks went from single digits to $40 per share or more.  During a bear market things are on sale.

Unfortunately, while the sales manager at the department store may be scared when she needs to discount the slacks 50% to get customers in the store, people don’t feel fear and pain when they see slacks on sale.  They may regret buying a pair a few weeks earlier for twice as much, and some of the more opportunistic individuals may actually bring the other pair back and then buy a new pair to get the discount, but seeing the slacks on sale doesn’t make them scared to buy another pair.  They know what the fair price for a pair of slacks is and are able to judge if something is a bargain.

Stocks really act the same way.  They have a fair price based upon the value of their business and their potential to generate earnings in the future, but they may trade at a substantial discount to that price at times.  Other times they may trade at a huge surplus to the fair price.

One stock picking strategy that is based on looking at stocks that are at a discount is called value investing.  A value investor will only buy stocks if they are cheap compared to value that he calculates.  He will then hold the stock until it goes up in price to the point where it is well above its fair value, making it overvalued.

There are mutual funds that use a value investing strategy.  Generally they will have the name “value” in their description.  You can also look at the prospectus, which normally has a diagram that shows if a fund is value oriented or growth oriented.  In the past value funds have outperformed growth funds over long periods of time.  They have not done so well in the past ten to fifteen years, but they will probably outperform again in the future.

So maybe consider adding a value fund to your portfolio.  Also realize that market downturns actually create great opportunities to see rapid gains.  Sure the stocks that you already own will decline in price, but if you can find some more money to invest you’ll end up far ahead once stocks recover.  Market declines tend to take good stocks down in price with bad ones.  The bad ones go bankrupt and disappear, but the good ones emerge stronger than ever with fewer competitors.  Don’t sell in a bear market.  If you’ll need the money in the near future, you should sell while things still look bright before the decline starts.  If you don’t, have confidence that things will recover – the long-term direction of the market is always up.

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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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