The silver lining to a bear market
Okay, it's not blindingly bright. But it's there if you know where to look.
December 31, 2002: 4:06 PM EST
By Jeanne Sahadi, CNN/Money Staff Writer

NEW YORK (CNN/Money) - There are countless reasons to feel rotten about a bear market that has left stocks mired in the red three years in a row.

Most investors have lost money, it will take quite awhile to make that money back and while some stock strategists are optimistic about 2003, any bullishness is tempered by continued concerns over the economy, corporate earnings and a possible war with Iraq.

But there are some reasons to be thankful for the stock-lashing, particularly if you're a young investor with long-term investing goals.

For starters, if you're reading this you've obviously survived a critical rite of passage. "It's almost like something every generation needs to learn from," said Jeff Hirsch, editor and publisher of the "Stock Traders Almanac."

Indeed, a prolonged decline in stocks offers a series of Big Bad Bear lessons that ultimately make you a better investor if you heed them.

Cheap and average can be good. Bear markets provide an opportunity to buy shares on the cheap relative to their prices in future years. And they reinforce the value of dollar-cost averaging (investing small amounts at regular intervals, such as when you automatically contribute to your 401(k) every month).

By dollar-cost averaging, you do three things: lower your average buying costs by purchasing shares of a mutual fund or stock at their lows, their highs and everything in between; mitigate your losses during downturns; and position yourself to benefit when stocks stage a recovery.

No one knows when a recovery will occur, of course. But history shows that steep gains can be made right on the heels of a bear market's true bottom. For example, stocks rose 38 percent between October 1974 and September 1975, immediately following the end of the 1973-74 bear market, according to investment research firm Ibbotson Associates.

One way to illustrate the benefits of continuing to buy into a bear market is to compare two hypothetical investors. The first investor has a balance of $33,600 invested in the S&P 500 on Jan. 1, 1973 and doesn't contribute another dollar throughout the 21-month bear market that follows nor during the 21-month recovery period that begins in October 1974. The second investor has a $0 balance on Jan. 1, 1973 and contributes $800 a month for the entire 42-month period, for a total investment of $33,600.

By the end of the 42 months, according to Ibbotson, the first investor has recovered his $33,600, while the second investor has $41,204.

Love the long term. Bear markets test your mettle as an investor. If you're a long-term investor -- say you're saving for retirement -- you should keep your eye on the prize and be more concerned with long-term issues than short-term news, said Peng Chen, Ibbotson's research director.

If you believe in the U.S. economy, then you have good reason to believe stocks will rise over time since the economy has been a key driver of the stock market, Chen said. Despite its recent woes, "the economy is fundamentally strong," he added.

In a study of stock performance on the S&P 500 over all the 10-year rolling periods between 1926 and 2001, Ibbotson found that stocks lost money during only two of them -- from 1929 to 1938 and from 1930 to 1939.

During the other periods -- of which there were 65 -- stocks rose anywhere from 1.24 percent on average (between 1965 and 1974) to 20.06 percent (from 1949 to 1958).

Take your losses like a smart person. If you had a nickel for every time you invested in a lemon, you'd be wealthy, right? Well, get some of that nickel from Uncle Sam. If you're investing in a taxable account, be sure to capture the capital losses from the sale of your lemons and deduct them on your tax return. "That will enhance your after-tax return in the long run," Chen said.

Check your heart rate. A bear market road-tests your appetite for risk and forces you to reassess whether you really are as risk tolerant as your battered portfolio suggests, said certified financial planner Deena Katz, author of "Taking Charge of Your Retirement" and president of Evensky, Brown & Katz in Coral Gables, Fla.

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"There's no riskless investment," Katz said. That's why it's important to have an investing plan that suits your risk tolerance and then stick to it. "The worst thing you can do is bail out mid-plan," she added.

A struggling stock market also teaches you to diversify your investments, to have some money in bonds and cash, and to sell periodically when you have profits, Hirsch said. As with dollar-cost averaging, diversifying and capturing gains can help mitigate losses when stocks head south.

For investors who are tired of trying to read the stock market's often confusing tea leaves, Katz recommends indexing. "Go into index funds and leave them alone," she said. "They're like shooting par. Wouldn't you like to shoot par for the rest of your life?"

Check your inner control freak. If they teach you nothing else, bear markets show you can't control the market. But they're a reminder that you can control three things critical to a successful long-term portfolio: how much you spend, how much you save and how you allocate your investments, Chen said.

And whenever you find yourself mourning the loss of those long-gone, no-brainer, bullish days of yesteryear, remember, Katz said, "No one learns anything from a market that goes sky-high."  Top of page

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