Business - Being ready for the next bear market

March 9 marked the one-year anniversary of the new bull market for stocks.

The S&P 500 index was up 72 percent through that year, and the index for foreign stocks, EAFE, was up 76 percent. Those results were the best for stocks worldwide since 2003, which also marked the first year that followed the last bear market.

A more sobering anniversary also took place last week, on March 10. That day marked the 10th anniversary of the peak of the tech stock bubble that burst back on March 10, 2000. That day ushered in the two-and-a-half-year bear market that ended Oct. 9, 2002.

What have stock market investors learned from the roller coaster decade of the 2000s? What have they learned from the turmoil and triumph of 2008 and 2009, which are much fresher in our minds?

When examining investors' behavior, the answer, apparently, is "relatively little." While we have seen huge gains since March, 2009, millions of investors failed to participate. They panicked at the worst moments in December 2008 and in the first quarter of 2009, went to cash and have stayed there. It is unlikely those investors ever will make up for their mistake.

Here's the reality most investors ignored: U.S. stocks have never experienced a bear market that wasn't followed by another bull market. My point is that investors must be patient while bear markets occur and stay invested. As I pointed out in my October 2009 column in this space, the stock market bottoms out three to six months before a recession ends. Once again, that scenario played out with stocks heading up beginning March 9, 2009, about four months before the economy bottomed out as of June 30, 2009. My point is you must also be patient as recessions occur, and stay invested.

Investors can do the right thing for their financial futures the next time a bear market or recession unfolds. Dalbar Inc. -- a Boston market research firm that regularly surveys investor behavior -- in 2009 once again analyzed the flows of retail investors' money in and out of mutual funds.

Through the 20-year period that ended Dec. 31, 2008, Dalbar's analysis shows the S&P 500 gained 8.4 percent, the broad bond market gained 7.4 percent and inflation 2.9 percent (all numbers annualized).

So if investors had just put money into an S&P 500 index fund and stayed put through those two decades, they would have earned almost a 5.5 percent return above inflation. That works out to a total return of 289 percent above inflation.

In reality, however, investors only held their mutual funds for an average of three to five years. They jumped in and out of funds, often chasing returns at just the wrong times. As a result, the average investor in mutual funds over that 20-year period earned only 1.87 percent in stock funds and 0.77 percent in bond funds. When adjusted for inflation, the typical investor lost money for 20 years.

Have investors' behaviors changed? From March 1, 2009 through Jan. 31, 2010, stock mutual funds received only $21.2 billion of net new money, which is tiny for a sector with roughly $4 trillion in assets. Meanwhile, bond funds' assets increased $328 billion in the same time period.

That means that during a period when stock market returns have been among the best ever, new money going into stock funds has been negligible and bond funds have received 15 times as much new money.

Here's what you must do to successfully navigate turbulent market conditions:

* Be a long-term investor at all times. Don't panic and sell when the markets or the economy suffers. The stock and bond markets will work for you, but only if you're continually invested.

* Be an investor, not a speculator. Don't chase the latest fad or hot tip.

* Have realistic expectations -- 5 to 8 percent per year total return from a balanced portfolio of quality stock and bond investments is realistic.

* Reduce risk as you age -- invest 50 to 70 percent in stocks in your 50s; 40 to 60 percent in your 60s; 30 to 40 percent in your 70s and 20 to 30 percent in your 80s.

* Find an experienced investment advisor with a quality track record you can trust.

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Dana Consler is senior vice president of Karpus Investment Management, an independent registered investment advisor in Pittsford, N.Y.

Published: Tue, Mar 23, 2010

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