Last year, I wrote an article entitled Understanding a Bear Market. The
first sentence read, "If you've only begun investing in the past few
years, you aren't aware of what a bear market is." Unfortunately, that
isn't the case anymore. In the past few months, Wall Street has reeled,
stumbled, picked up speed, fallen on its side, and gone in circles.
Professional and average investors alike have no idea where the market
is headed, but everyone seems to have an opinion.
What is a bear market and what causes it?
By
definition, a bear market is when the stock market falls for a
prolonged period of time, usually by twenty percent or more. It is the
opposite of a bull market. This sharp decline in stock prices is
normally due to a decrease in corporate profits, or a correction of
overvaluation (i.e., stocks were too expensive and fell to more
reasonable levels). Investors who are scared by these lower earnings or
lofty valuations sell their stock, causing the price to drop. This
causes other investors to worry about losing the money they've invested,
so they sell as well; the vicious cycle begins.
One of the best
examples of a prolonged bear market is that of 1970's when stocks went
sideways for well over a decade. Experiences such as these are generally
what scare would-be investors away from investing. Ironically, this
keeps the bear market alive; because no few buyers are purchasing
investments, the selling continues.
How does a bear market affect my investments?
Generally,
a bear market will cause the securities you already own to drop in
price. The decline in their value may be sudden, or it may be prolonged
over the course of time, but the end result is the same: the quoted
value of your holdings is lower. This leads to two fundamental
principles:
1.) A bear market is only bad if you plan on selling your stock or need your money immediately.
2.) Falling stock prices and depressed markets are the friend of the long-term, value investor.
In
other words, if you invest with the intent to hold your investments for
decades, a bear market is a great opportunity to buy. It always amazes
me that the "experts" advocate selling after the market has fallen. The
time to sell was before your stocks lost value. If they know everything
about your money, why they didn't warn you the crash was coming in the
first place?
What do I do with my money in a bear market?
The
first thing you need to do is to look for companies and funds that are
going to be fine ten or twenty years down the road. If the market
crashed tomorrow and caused Gillette's stock price to fall 30%, people
are still going to buy razors. The basics of the business haven't
changed. This brings us to our third principle:
3.) You must
learn to separate the stock price from the underlying business. They
have very little to do with each other over the short-term.
When
you understand this, you will see falling stock markets like a clearance
sale at your favorite furniture store; load up on it while you can,
because history has borne out that prices will eventually return to more
reasonable levels.
Courtesy:
About.com
Investing for Beginners
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