The bear market has taken a huge toll on everybody’s investments. I read numerous personal finance blogs, most of which write an end of year financial status round-up. Many of these bloggers are experiencing significant declines in stock market investments, so much that their net worth has decreased over the course of 2008. Fortunately, the majority of my savings was held in cash for a condo down payment. For this reason I didn’t experience too much of an effect from this bear market, however, I did learn a very valuable lesson from this bear market, know your risk aversion.
Risk aversion is how well you handle risk. A risk averse person will trade higher returns in order to lower risk. A less risk averse person will take on higher risk to gain higher returns. Risk aversion is not something that is consistent from person to person. Knowing the degree of your risk aversion is crucial to surviving the ups and downs of the stock market.
If you have never experienced a bear market, which was true for me up until now, you may think you aren’t risk averse, that is until you’ve lost 50% of your portfolio. Everybody can ride the market highs, but can your stomach handle the lows?
Not knowing your how risk averse you are can lead to making one of the largest mistakes of your investing career: buy high and sell low.
Past Bear Markets
Even though I didn’t have a lot of money in the stock market, I have learned that I have a high tolerance for risk. I know that I am just beginning my investment journey and I have over 30 years to recoup any early losses. Studying past bear markets has made me confident that the market will rebound and rebound in a big way.
Investing at today’s discounted prices is the equivalent of investing in 1997, at least according to the S&P 500. Back in 1997, the S&P 500 was in the 800 range, the same as it is right now. That’s 11 years worth of stock investing that I hope to take advantage of when the market rebounds.
Also, a market similar to the current market existed between the years of 1963 to 1974. In 1963, the S&P 500 was in the 60’s. The S&P 500 peaked around 118 in 1972 before taking a nosedive back to the 60’s in 1974. If you had sold your position because you did not correctly know how risk averse you were, you would have missed out on the gains the next 11 years provided. Over the course of the next 11 years, the S&P 500 increased in value into the 250’s.
The stock market is not guaranteed to increase over the short-term. Over the long haul, however, the stock market will outpace inflation and help secure a happy and financially independent retirement. A bear market such as our current market, is the only time to really be able to determine how risk averse you are. Can you sleep at night knowing that up to 50% of your retirement savings have vanished over the past year? Can you sleep easily knowing the loss is only a paper loss and the market will rebound? Are you willing to pump extra money into the market during a bear market? Your answers to these questions will help you determine a suitable stock/bond ratio for your investment plan. I’m confident that the stock market will rebound and if you don’t believe me, check out the history of the S&P 500 for yourself.