Ask the Readers: Advice during a Bear Market?

Jordan emailed me an interesting question regarding giving advice during a bear market that really hit home for me.

What do you say to someone who has completely lost faith in this falling
market? If they’ve lost their ever loving minds and now think there will be
bank runs, CDIC insurance won’t work, and they are too scared to invest in
anything with any amount of risk.

Do you try to help out your family/friends or keep your investment
knowledge to yourself to avoid possible blow back?

My rule of thumb is to never give advice unless it is asked for.  So even in the scenario of a family member/friend losing all faith in the markets, it is probably due to losing a bunch of money in equities over the past year.  The last thing they want to hear is someone telling them what to do after the fact.

However, if I was asked what I thought of the current market crash, I would tell them what I’ve been writing about here.  That is, although this may be a significant market correction, the markets will recover.  Every major bear market in the past felt like the end of the world, but the markets have always bounced back.  So if you’re invested for the long term, I personally would hang tight, and even consider buying when opportunities present itself.

In addition, this market is a true gut check for new and seasoned investors alike.  Market conditions like these reveal your real risk tolerance.  If the current volatility of the markets is causing you to lose sleep, then it’s time to review your equity/bond asset allocation and adjust accordingly.

So that’s what I would do in this situation.  What would you do?

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FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.
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Gates VP
12 years ago

Hey @Greg, here’s the Bank of Canada inflation calculator. I use this on a regular basis when anyone talks in spans of more than 10 years. Please note that Canadian stats do differ from US stats, Canada has been running a surplus for several years and hasn’t needed to print as much money.

I definitely agree that there may be some government “fudging” of these numbers (whether by malice or by poor model). However, even if the real mean is 50% higher (say $170k instead of $145k), the house has still demonstrated significant post-inflation growth.

Now what you think of these “Shadowstats” is up to you. Based on anecdotal evidence, I’m tempted to agree that US inflation is much higher than reported. I see the US government basically operating an inflationary recession racket for as long as they can to try to buy their way out of this mess. (when you have an army larger than the rest of the world combined you can pull this stuff off). But that’s just my guess.

However, if you look at the “Shadowstats” unemployment numbers, you’re now asking a very different question. That question is “how do we handle all of these exceptions”. Inflation is a pretty simple “how much more does this stuff cost?”. But what counts as Unemployment? Do you count people on voluntary retirement? How about people who are switching jobs? Do part-timers count as less than one job? What about people who hold down two jobs? What if I do seasonal work or contract work and end up “unemployed” for periods of time? Do you include employed people who are dependents of a regular wage-earner? Do you exclude people who aren’t earning what would be considered a “living wage”? How about people on worker’s comp or maternity leave?

In Alberta a couple of years back, unemployment was at 3.5%, but everybody had a job and nearly every employer was looking for more people. And I do mean “every”, this was “negative unemployment”. Turns out 3.5% was pretty much the bottom of the model. It was basically impossible to get to zero :)

The point is, the models for measuring these things are extremely complex and have to make a lot of assumptions and value judgments based on what they’re trying to measure. Shadowstats is effectively changing some of these decisions and spitting out a new number. That number could be “better” or “worse” depending on your interpretation of those terms.

What is safe to say is that they probably have a good handle on the US increase in money supply over the last couple of years. To put this into perspective. Canada has a national debt around $600B and we’re about 1/10 of the size of the US. That’s about $500B USD, which means that the government “bailout” package is basically larger than the entire Canadian debt. Or another way, Canadian GDP is around $1200B so the US government basically created 6+ months of Canadian economy with their last bill :)

Greg
12 years ago

@Gate VP – What is the rate of inflation that your parents house has doubled? When inflation rates are too high, governments change how they calculate the inflation rate. It doesn’t make the actual rate lower, it just makes the reported rate lower.
I haven’t read any Garth Turner, but I have read and watched some of the stuff published by Chris Martenson (http://www.chrismartenson.com/crashcourse). He seems to believe that the US dollar and therefore the whole US economy is going to collapse. There is also a website that tracks inflation and other statistics comparing the current calculations with how they were previously calculated (http://www.shadowstats.com/alternate_data). By their reconing, the current inflation rate is more like 12%.
On the other hand you have guys like Warren Buffet saying now is a great time to buy.
At the moment I’m not panicking, but I guess I’m like a deer frozen in the headlights. I don’t know which way to go.

Novice
12 years ago

@ Brandon – thank god someone else thinks he’s scary! I’m not going to wade into the argument of whether or not real estate will fall 40% or more, just that the man sells a lot of books to scared people and that upsets me as it seems to preying on the scared. I read his blog for entertainment (it should be noted he does not allow all postings to appear on his site) but entertainment only. According to his latest post I should sell my Toronto centre (real Toronto, not Brampton or Pickering “Toronto”) urban home and move to Barrie or beyond and learn to hunt for my own food. I think I’ll take my chances. For what it’s worth, I think real estate is somewhat overvalued but I don’t think it will drop anywhere near dramatically as he predicts or will stay down more than 1-2 years. My problem with Turner, in addition to his propensity to edit the record/facts to suit his current position (ie. anti-gst cuts to pro-gst cuts, or saying that mp’s should have a byelection if they switch parties and then switching parties but no byelection – his consitutents let him know what they thought about that) is that he’s been predicting real estate crashes / economic collapse every month for the past 5 years – he’s the broken clock of economic predictors – even a broken clock is still right twice a day afterall.

Gates VP
12 years ago

@John Doe: All real estate has some sort of building value (though depreciating), while detached homes/properties have a land value (long term appreciating/holding its value), yes?

I think the answer here is kind of yes and no. Yes what you’ve said is correct and no it’s incomplete.

The house itself does have some type of value. But historically, the change in housing values has averaged the change in inflation.

Now, we’re just getting off a giant 15+ year housing run, so it’s hard to remember when housing values didn’t grow. My parents bought a house in Winnipeg for $100k in 1990. Growing at inflation that house is now worth $145k, but the market rate for houses on that block is about $270k. So not only is the house 15 years older but it’s doubled after inflation? Yeah, it’s easy to think that the land value has increased, but have you been to Winnipeg lately? Winnipeg has so much open space they still have gravel roads inside the city perimeter.

So if you own a rental place, you can either rent it for income or sell it. On average, the house value moves with inflation (ignore the last few years), so your sale will result in a gain in dollar value but no gain in real purchasing power. In fact, since the rental isn’t your primary residence, you’ll pay taxes on the capital gains, so you’ll likely lose purchasing power. That doesn’t include the fact that the home is both physically depreciating and it is costing you property taxes.

So the reason the PF Bloggers think of it as a rental is simply that the rental can operate on a cash-flow positive basis. In this way, owning a rental home is much like owning a dividend-bearing stock (but more complicated and time-consuming… hmmm)

Millionaireby45
12 years ago

A flaw in many peoples philosophy about investing is two fold:
1) The past is a valid representation of the future.
2) They only consider the positives of the past.

Approximately every 8 years we go through a recession and there have been times in the past where the market has trended sideways for over ten years (i.e. no gains).

The problem with most people’s investment philosophy is that they take the losses too personal and then make irrational decisions. I have spoken to numerous people who have taken all there retirement savings out of the market and bonds and placed it into a savings account. Other people become much more aggressive when they shouldn’t and a third group makes no changes at all.

Loosing a large percentage of your portfolio sucks but this also creates opportunities that may not have existed a year ago. As an example, BMO just issued preferred shares with a dividend of 6.5%. These pref shares with such a large dividend did not exist a year ago. Investors should also consider options (put options can be used as insurance to protect a portfolio from huge losses). These are just two examples.

Although equities have fallen almost 45% from there highs, it is still possible for the markets to decrease a significant amount from where they are today. Each person’s situation is different and it is important to evaluate your portfolio on a regular basis and make rational changes based on your situation.

John Doe
12 years ago

@jesse
..It’s true that if there’s a large enough amount of (speculative) real estate investment, there’s a possibility the housing market could take a large tumble. To tell you the truth , I do actually know a few people in that boat. However, they still aren’t leveraged to the degree that they simply would *have* to sell in a crashing market as they bring in enough income to sit on the property and wait. Correct me if I’m wrong, but sharp real estate crashes are precipitated by sharp increases in foreclosures, yes? Since foreclosures are a option of last resort, if the economy holds up and people still have jobs,
IMO don’t see a *worst case* Phonenix/Las Vegas 30% drop on our hands.

Also, I don’t understand the comment about future cash flows from rents being the *only* value of a property. All real estate has some sort of building value (though depreciating), while detached homes/properties have a land value (long term appreciating/holding its value), yes?

To get on my soapbox for a second……I guess I’m only saying these things as the “fundamentals” of investment seem to only be the “fundamentals” because somebody of influence says they are. Our global system of (fiat) currency is flawed to begin with anyway, but hey, it’s what we’ve got. To cut a long spiel short, if enough people believe in something, they’ll probably find a way to make it happen. If enough people say “terrible housing crash”, it’ll probably happen, and really, that’s in the best interest of the minority.

kevin
12 years ago

I have been telling my friends that what I am doing is not working. So don’t follow me. Value investing has been a heartbreak hotel for the last few years.

Scott
12 years ago

I’ve given advice to friends and family during the last 2+ months but it was more general than specific: don’t quit your day job; get out of debt ASAP; wait until 2010 to splurge on ‘Item X’; and hang onto your hat because it’s going to get even bumpier!

I have no idea what the market or economy is going to do and I would bet most of the “pros” don’t really know either (there’s a new surprise coming out of America every day!). My answer — down even more. No idea how much or for how long, just down.

Cash Canuck
12 years ago

I think GatesVP makes a good point. Maybe not so tactfully, but how can you tactfully say “I told you so”?

I think part of the problem lies with mutual funds salespeople masquerading as financial planners/advisors/consultants. These people are compensated based on the sale of equity based funds, so they’ll naturally want to sell those products that give them the biggest paycheck… I would. There is evidence to support the over-emphasis of equity funds. A good amount of panic selling is emanating from mutual funds redemptions, which are hitting record levels.

Before one even thinks about equities vs bonds et cetera, one should write down timelines on a piece of paper. “When do I want to spend the money I’m putting away?” If that number is anything less than five years, at least for my risk tolerance, I would put approximately 0% of my hard earned cash into equities.

I think failure to consider timelines is a major fault of the planning process for most people. I know that I can weather the storm in the markets because the portion of my savings that resides in equities is not going to be sold for a good, long time.

Brandon
12 years ago

Novice, I was one of those guys who went vacationing during the dreaded Y2K… but after reading Garth Turners blog I’m almost tempted to prepare for his visions of ultimate disaster!

Garth is scary!