It has been almost 12 years since investors witnessed a punishing bear market during the Global Financial Crisis (GFC) of 2008-2009.
The absence of an extended bear market may have lulled many new investors into a false sense of security, as they had never experienced the turbulence associated with persistently low valuations and a sharp drop in confidence.
While no one should invest with the constant expectation of a bear market or downturn, I feel it’s useful to examine the GFC for learning points.
Having been through the GFC first-hand, and being invested throughout the entire period, I thought it would be useful to share investment lessons gleaned from this once-in-a-lifetime event.
Companies may look cheap … until they go bankrupt
During the crisis, strong ripples reverberated through the globe as the entire US financial system was on the verge of collapse.
As funds from banks and financial institutions seized up, credit was made unavailable almost overnight.
This event resulted in severe stress for companies that could not roll over their loans as there was insufficient liquidity in the system.
Even popular REITs were not spared and faced a cash crunch.
The lesson here is that although certain companies may look decidedly cheap during a bear market, investors should be wary of those with high debt levels or imminent refinancing concerns.
Some companies are literally “cheap for a good reason” as the market is pricing in the probability of bankruptcy should they be unable to obtain financing to carry on daily operations.
Avoid borrowing to make quick gains
There were instances where a few bold but ultimately foolish short-term traders borrowed money to short the market. It seemed like a good idea because the market was only heading in one direction at the time – down.
What investors may not be aware of is that bear markets are periodically punctuated by sharp reversals or upswings, and these unpredictable fits that can swiftly kill off traders with leveraged positions.
Keep one simple advice in mind: do NOT borrow money during a bear market as its sharp swings may bankrupt you.
Invest slowly and always keep cash handy
As bear markets can last anywhere from 6 months to 2 years, it’s advisable to space out your purchases to ensure that you have sufficient savings.
It’s useful to keep some cash handy at all times.
The greatest mistake an investor can make is to go all-in at the beginning of the bear market, only to see valuations collapse further to rock-bottom levels without having any cash handy to average down.
Friends of mine have suggested a mechanical method to make it easier to allocate funds during a bear market, and this shall be tagged to the % drop in the market.
An example would be to commit 10% of your funds when the market falls 5% and another 10% for every subsequent 5% drop. Of course, this method can be tweaked to suit an investor’s personal tolerance level and preferences, but it does serve to take emotions out of when to inject money into the market.
Manage your emotions
Speaking of emotions, this is probably the toughest aspect for investors to manage through a bear market.
On a personal note, I felt discouraged and disheartened when I witnessed the value of my portfolio plummeting, and had to be constantly comforted and reminded by my loved ones that things would eventually get better.
During those dark days, there was no assurance that any improvements would come.
As such, it can be extremely tough to sit still, watching as significant amounts of unrealised losses build-up for an extended period of time.
That is why the support of friends and family is crucial during recessions and bear markets.
If we go at it alone, it can be tough to brave through an extended fall in share prices without a word of confidence from the people around you.
Another option is to hang out with fellow investors who also share a long-term philosophy and are veterans who have been through prior downturns (for example, the Asian Financial Crisis back in 1997-1998).
These people help to put things in perspective and can allow an investor to enjoy a good night’s sleep.
Get Smart: History rhymes
In the past 12 years, there have been periods of time where markets dipped precipitously. However, the recovery has usually been swift, as compared to the GFC.
As prolonged declines are rare and uncommon, not many investors may have the opportunity to experience and learn from them.
The GFC is a worthy event to study as there could be valuable lessons that can be applied forward.
The new GFC-like event might not happen the same way. But as the saying goes: history never repeats itself, but it often does rhyme.
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Disclosure: Royston Yang does not own any of the shares mentioned.