Investing During a Bull Market (And How to Prepare for the Bear)

2018-09-07T11:38:19+00:00
10 Shares

Imagine you open your email and it’s a promotional note from your local grocery store. The message? Soon their company will reduce prices on everything in their store by 25%. You don’t know the exact date of the promotion or how long it will last, but they promise it’s on its way.

How do you react to the news?

It wouldn’t make sense to completely stop buying groceries until the sale occurs. After all, your family needs to eat. But it also wouldn’t make sense to go about your life without a plan to capitalize on the discounted buying opportunity.

The Real-Life Grocery Store Promo

Whether you realized it or not, you’ve already received notice of this promotion. It didn’t come from your grocery store, but rather the stock market.

At the time of publication, we’re in the midst of the longest bull market since the 1900. This current run is the longest stretch the market has ever gone without a 20% drop.

During this time, the S&P 500 has quadrupled from its 2009 value. So, what are the implications for investors?

A drop in the market of at least 20% is likely to occur in the next 24 months. But how do we plan for a grocery store promotion without a definitive start date? I have a few ideas.

The first distinction I want to make is that no investor, under any market conditions, should bring their regular investment contributions to a complete halt. Not even in the name of the most fundamentally sound speculation.

But there is another approach that could make a lot of sense. Let’s say you take a dollar cost averaging approach and consistently invest 40% of your take-home pay in the market. Since you fully believe there will be an upcoming sale, perhaps you take 2% of that money and instead divert it to your cash reserve, i.e., your stock fire sale fund. And maybe the next month you do the same thing but holdback 3% for your fire sale fund.

I suggest increasing your fire sale fund allocation by another 1% each month until you reach a point you aren’t comfortable exceeding. Perhaps your comfortable with holding back 5%. Or maybe 8%.

I rationalize this monthly increase in cash holdings based on statistician contentions. Statisticians would contend that an ensuing bear market becomes exponentially more likely the further we advance into unprecedented territory. That makes it exponentially more reasonable to have irregularly high cash reserves moving forward.

You should probably hold your extra cash reserves in the same account as your emergency fund. Just like an emergency fund is designed for quick access, you’ll want easy access to your cash reserves whenever the fire sale kicks off!

Opportunity Cost

What if the bull market continues for another 4 years before we experience a 20% or greater drop?

This is certainly a risk. But I considered that possibility as I crafted my allocation schedule. If I was certain that the market would drop in the next 10 months, suggesting that you do anything but hoard all your cash in the months would be foolish.

My strategy redistributes my cash assets in a way commensurate with what the market is telling will likely happen. By doing so, I’m hedging my bets by not placing all my eggs in the bear market basket.

I feel another 4 years of a bull market is very unlikely. However, even if the bull market surges ahead for another 48 magical months, you’ll still probably make up most of the ground you lost when the bear market finally sets in. The extent of your net loss or gain will depend on how violent the bear market drop is. In any event, this makes the increased cash allocation a soft bet against the market run, but not a wild one.

A Few Final Thoughts

Long term wealth building should revolve around a timeless carefully picked investment strategy. Deviation from your plan should only involve minor changes that are supported by relevant historical data.

If you decide to continue your exact investment strategy amidst our unprecedented bull market there is nothing wrong with that. In my view, however, unique circumstances offer creative investors opportunities to optimize their results. And this inexplicably long run of stock market returns may be an example of exactly that.

WHAT'S YOUR PLAN FOR FINANCIAL FREEDOM?
Thousands of people are already using TDB to improve their finances. Why not join the community and learn how to get more from your money?
We hate spam. Your email address will not be sold or shared with anyone else.
10 Shares

About the Author:

Darian
Hi, I'm Darian! I am a twenty-something insurance professional working on my ultimate quest for financial freedom. I hope you enjoyed this article. Stick around to learn more about financial strategies to manage debt, save more, spend less, and live the life you want.