How to Build Big Wealth in a Bear Market
October of 1987 was a dark month for investors.
Earlier that year, the Dow was surging. It peaked in August, up 44-percent from the previous twelve months. Investors were thrilled.
Then the other shoe dropped.
On Oct. 14th the Dow dropped nearly four-percent, a record at the time. Two days later the market experienced another record drop of just under five-percent.
Now investors were really spooked.
When the markets re-opened after the weekend, Black Monday began in earnest. Stock markets around the world crashed and burned. The Dow was in freefall. It was down 22-percent by closing time.
The one day loss was the largest in history -- almost 10-percent higher than 1929's drop. The Dow lost 30-percent in less than a week.
Raw panic was everywhere. The specter of another Great Depression loomed. Rumors of broker suicide watches and banks going under were spread by the media.
It was the worst case scenario. A disaster of almost incomprehensible proportions.
And the most amazing thing about it all?
It was just a blip on the historical radar.
The wealth-building power of the bear
Black Monday was undoubtedly a disaster. Yet the Dow finished with positive growth for the year. Just two years later, the Dow was once again setting all-time highs.
The much-dreaded reprise of 1929 never came.
It's a good reminder to keep things in perspective. To focus on the long-term game. To not get caught-up in mass hysteria or group thinking. To have the guts of a cat burglar and the patience of Job.
Now, it's true that it took the Dow a couple of decades to recover from the crash of 1929. Yet these days bear markets don't have nearly the same staying power.
Even two high-profile examples -- Black Monday and our last bear market in 2007 -- proved to be closer to hiccups than long-term doldrums. Other than the tech bubble-linked bear market of 2000-2002, most have been brief and only moderately painful.
The market has undergone transformative changes just in the last 30 or 40 years. New rules and safeguards. The rise of ultra-fast computer trading. Turbocharged growth thanks to the economic boom of the Reagan 1980s. Millions of new people coming onboard during the tech gold rush of the 1990s. Today's market participation is vastly higher.
Bear markets offer their own brand of opportunity. Think of it as a natural correction. A way to maintain market homeostasis.
If you don't need to tap your investments in the near future, a bear market is very fertile ground for wealth building.
When the market drops, your cash buys more stock, meaning you build greater equity. Though it sounds counterintuitive, you can actually build more wealth during market downturns.
So which tactics should you employ?
If a bear market is about to develop, a portfolio shift may be in order. Tilting toward dividend-paying blue chips and away from smaller, less stable firms is a common tactic.
Adopting a defensive posture by investing in something like utilities or healthcare rather than retail or entertainment is another tried and true technique.
Companies with excellent long-term prospects, competitive advantages and savvy management teams make great bear market targets. Unless we experience a global meltdown on an unprecedented scale, such firms will recover strongly.
Bear markets are also breeding grounds for irrationality. Valuations may be affected by this, creating an opportunity to buy great stocks at an excellent price.
Yet don't waste time trying to time the market. By waiting for the absolute lowest price, you're likely to miss valuable buying opportunities.
Shorting stocks or short ETFs may also make sense, depending on your position.
Finally, don't forget about tax implications. If you sell and take a loss, you can write such losses off against your capital gains.
Bear markets provide hard-won experience. They also build wealth.
By learning how to navigate through choppy water, you'll better prepare yourself to seize massive opportunities during the next down cycle.