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Introduction | Bear Market Considerations | Calculate Your Survival | How to Handle a Bear Market

How to Reason With It

The experience of investing during the 1970s bear market should give you a few pointers:

  1. Diversification tends to minimize your losses. If you invested across several asset classes, your investment probably did not decline as much as it would have if you put all your investment into one class. Investing in both equity (stock) and fixed income (bond, money market, etc.) assets tends to reduce your loss in a market decline.
  2. The most lucrative stocks can also be the biggest losers. During bull markets, small cap stocks have often provided investors with the greatest returns. But as we saw in the 1970s, they can also account for the biggest losses during a bear market. We're not trying to scare you away from small cap stocks, or any investment type, for that matter. But as you've already learned, high risk and high potential returns go hand in hand. There's another point to consider. The type of investing we just did -- contributing a lump sum at the beginning of the investment period and seeing how it performed, is not the way you invest in a 401(k) plan. The difference between putting the entire $10,000 into the market at once and investing it in smaller installments (as you would invest in a 401(k)) is more than just an accounting distinction. It can actually save you money, as you'll see in our third pointer:
  3. Disciplined investors do not suffer as much in a bear market. With a 401(k) plan, you contribute a certain amount of your salary each pay period to your retirement investments. With an incremental investment approach, you will always be buying a batch of assets at the current price. So if, for example, the net asset value of your mutual fund goes down, you will actually be picking up shares at a lower price -- and getting more shares as a result. This phenomenon is known as dollar cost averaging. A market downturn will affect your overall investment less if you use dollar cost averaging than if you invested a lump sum all at once. Let's take a look at what would have happened if, instead of investing your entire $10,000 up front, you had invested a portion of that money each month during the 73-74 bear market. The total amount of your investment by September, 1974, will still come to $10,000, but you will have been investing regularly, as you would in a 401(k) plan. Remember, you will still lose money because the market during this time did nothing but go down, down, down. But you may be surprised by what happens with your overall investment.

    Click here to Calculate Your Survival.

  4. One final pointer. You can't make money on an investment unless the investment does well, which isn't going to happen during a bear market (for example, the S&P 500 didn't recover its full pre-1973 value until 1982). But dollar cost averaging can reduce your loss during a bear market. With a systematic investment plan like a 401(k), your investments have a better chance to escape being eaten by a bear.

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.
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