Mauled By the Bear Market? 6 Steps to Financial Recovery

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9/2/08

Has your portfolio been savaged by this new edition of a ‘Bear Market’? Are you feeling there’s no end in sight and have no hope of recovering what has been lost? Well, there are solutions and I hope to offer a few here.

Make no mistake, we are in a longer term ‘Bear Market’ and there is no way of knowing when it will end. Having said that there are a number of strategies you can use to protect yourself, as outlined below. 

1) Investor, Know Thyself The very first step in being a successful investor is having a good understanding of who you are. By that I mean you must know how much risk you are able to tolerate, financially, psychologically and emotionally. For example, if you have a $10,000 account are you able to experience a loss, even temporarily, of $1,000, $2,000, or more, less?  If your portfolio of $100,000 slides to $90,000 of value, or $80,000, are you able to comfortably sleep at night? These types of temporary declines are very common in the stock market so you must understand in advance what amount of loss, if any, you are able to live with.

Solution: Carefully develop your investment portfolio to meet your personal risk tolerance. As a general rule you may reduce market risk by balancing your portfolio between a mix of stocks, bonds, and money market, and/or their mutual fund and exchange traded fund equivalents.

2) Are You Investing for Income, Future Growth, or Some Combination of Both?   It is very difficult and increases risk to use your investment account to receive income while at the same time attempting to protect and even grow your principal. For example, if you are withdrawing 4% annual income from your account and it goes down 10% in market value in one year, your account is worth 14% less than what you started with. Imagine three years in a row of market declines, as happened 2000 – 2002.

Solution: Build two portfolios, one for growth and one for income. The growth account could be filled with stocks and or the equivalent mutual and exchange traded funds. The second account, designed for income, could consist of income annuities, corporate and/or municipal bonds, or their equivalent mutual and exchange traded funds.

3) Invest With Tax Consequences Firmly in Mind Don’t let the tax tail wag the dog, but always build and manage your investment portfolio with strategies to minimize taxation. If your total return in one year is 9% and you give up 4% in taxes, you probably have not been as tax efficient as you could have been.

Solution: As much as possible use tax efficient strategies. For example you could place your income generating investments in municipal bonds, income annuities, and/or tax efficient vehicles like index income oriented mutual and exchange traded funds (ETF’s).

4) What to Do in an Existing ‘Bear Market’? Assess the damage, keep the better performers, and sell those that have generated the greatest losses. Don’t wait for them to get back to break even and then sell, a common mistake made by many. They may never come back, or it may take so long that you will have missed many other opportunities in the meantime.  

5) Keep Investment Costs Low Avoid buying investments that carry steep costs, many hidden from view. Front end loads, back end loads, markups, markdowns, internal expenses, surrender penalties and more await the unwary buyer.

Solution: If you are an accomplished self directed investor buy your investments through a discount brokerage firm like Schwab, TD Ameritrade, Fidelity etc. Buy only No-Load mutual funds, exchange traded funds, low transaction fee stocks and bonds. If you need guidance then at the risk of sounding self promotional seek out a registered investment advisor who works on a fee for service basis. This type of advisor has a fiduciary responsibility to place the interests of the client first and foremost, ahead of self interest and ahead of any financial services firm with which he or she may be affiliated.

6) Can You Protect Your Assets in a Long Term ‘Bear Market’? I believe the answer is yes you can. You do not have to ‘ride out’ a long term ‘Bear Market’, watching helplessly as you lose 20%, 30% or more as has happened to so many in the past.

Solution: Buy quality, low to moderate risk investments. If the long term trend is down, as is currently the case, sell those getting hit the hardest, move to money market or even partially to ‘inverse’ exchange traded funds. ‘Inverse’ funds are designed to do opposite of the respective index so if the major indexes are trending down you can reposition part of your portfolio into inverse ETF(s) moving in the opposite direction, as they are designed to do.

 

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