Understanding the Financial Market Life Cycle
Understanding the Financial Market Life Cycle
Don’t Panic — Bear Markets are Just a Normal Part of the Market Life Cycle as an Investor
After reaching highs in early January, the S&P 500 and NASDAQ both plunged into a bear market territory, falling more than 20% to close out the first half of 2022. This tumble prompted renewed interest in an age-old question: Are we in a bear market? And if so, what does that mean for the individual investor?
Bear markets are generally defined as a drop of 20% or more in an index or security
Some bear markets are short-lived, as we experienced in 2020 with the COVID-19 lockdown, but some can be prolonged, as we saw with the Great Recession.
Following the six-month tumble to start this year, investors are trying to determine whether security prices will continue falling or if the worst is behind them. Regardless, this news serves as a critical reminder that stock prices don’t simply go up in perpetuity, and a bear market can present investors with new opportunities.
There has been no shortage of bad news for investors in the first half of 2022
Between supply chain issues, labor shortages, spikes in home prices and rent, and the highest inflation in 40 years, investors have to worry about various risk factors to develop a sound investment strategy.
None of us has a crystal ball to peer into the future of the financial markets, so it doesn’t matter that investors can’t predict the future but rather how we respond to market turbulence and build our portfolios.
The Economic and Financial Markets Cycle
Behavioral finance experts tell us that investors often let emotions cloud their best judgment and drive decision-making that is ultimately at odds with their long-term investing goals when it comes to the economy and financial market cycles.
When markets shift, the temptation is for investors to buy high and then panic and sell low. The debate over whether or not we are currently in a recession is a popular topic on social media. Still, financial markets have already priced this economic contraction for equities and fixed-income securities. The real question is how long these headwinds will persist.
Investors have more access to important information about the economy and financial markets
Today, investors have more access to important information about the economy and financial markets than ever before. In addition, it has never been easier to begin trading with numerous financial technology “apps” offering easy access to trading platforms. Consequently, investors are much more likely to react — positively or negatively — to any market changes.
Experiencing nearly 13 years of market growth, many of today’s investors may have felt invincible, buying stocks or trading options before our economy turned toward recession.
Every investment may have seemed like a winner, and many people were making money. However, the extended market cycle — and historically unprecedented fiscal and monetary policy stimulus during the COVID lockdown — created false expectations. People thought that the good times would continue for the foreseeable future.
Unfortunately, many overconfident investors bought high — just as the market crested
“Don’t fight the Fed” is a commonly used phrase on Wall Street. During the peak of the COVID-19 pandemic, unprecedented fiscal and monetary policies created a significant tailwind for most investments.
Congress enacted laws to put money in the hands of companies and American consumers. As the federal government handed out stimulus money, the Federal Reserve had accommodative policies that pumped cash into the economy as well.
These policies extended the bull market through the pandemic’s early days, and many investors did great.
But “Don’t Fight The Fed” works in both directions. First, the Federal Reserve has pivoted to restrictive policies to try to contain inflation and is now aggressively raising interest rates.
As of this writing, inflation is still at the highest level since the early 1980s, so the Fed is likely to continue to use all weapons in its arsenal in an attempt to tamp down inflation.
With the significant pullback in equities in the first half, particularly in most of the large-cap technology names, fear is causing many retail investors to sell, thereby locking in their losses and limiting their ability to grow their money over the long term.
A Normal Part of the Ebb and Flow of the Market Cycle
Coming down from an extended bull market period, the market’s pullback from historical highs makes it difficult for most investors to understand that these ebbs and flows are a normal part of the market cycle. No market goes up forever, and stocks will eventually have to be repriced.
That said, no one knows what will happen in the markets day-to-day, so trying to time the market is often a fool’s errand — and panic is not a strategy. As long as you have the appropriate diversification in your portfolio based on your individual investment objectives, don’t panic! Instead, sit back, relax and let the market do its thing.
Diversify and Invest According to Your Timeline
A recession is also a normal part of the life cycle. As long as your portfolio is diversified and you’re investing according to the timeline for your specific goals, there is no reason to panic.
Investing to achieve various goals — whether to retire comfortably in 20 years, go on vacation next year or purchase a new vehicle within the next five years — can be pretty straightforward. The key is ensuring your investment allocations sync with the timelines for each goal. In addition, focus on the long term, diversify and avoid products with high fee structures.
Look at your time horizon for the objective for which you’re saving and invest according to that horizon. For example, if you are many years from retirement, your retirement allocation will probably be close to 100% in equities.
Your money should be in a well-diversified portfolio so you can walk away and forget about it.
The money you’re investing for your vacation next year will be mainly in cash and cash equivalents like certificates of deposit (CDs). However, for goals that may be a few years out, you should utilize fixed-income securities — perhaps fixed-income exchange-traded funds.
As your goal investment horizons get longer, equities become a more prominent and more significant part of that portfolio. But always be aware that if you are selling investments supporting long-term goals, you are effectively locking in the loss.
Diversification is Key to Any Long-Term Investment Strategy
Instead of having all your money in one security, it’s essential to allocate investments to each goal you’re saving toward. You might get rich if you’re investing all of your money into one stock, option, or cryptocurrency. But for everyone on social media bragging about how much money they made off one trade, for example, thousands of others lost everything.
As a result, investors need to understand the difference between investing and having a solid investing strategy versus speculation or gambling.
Do you understand the investment you are considering and why it is going higher or lower? While numerous media outlets now focus on short-term trading, investors must realize that this is speculation, not investing.
Long-Term Investing Can and Should be Easy to Understand
Taking a long-term approach to investment should not be stressful, nor should it take a lot of effort or management. But developing a long-term investment strategy isn’t the hard part — it’s sticking to that plan in the face of tumultuous market environments.
As investors, we should feel good about putting our money to work for us, not stressed out, panicky, or constantly checking for updates.
Stay away from get-rich-quick schemes and short-term speculation that is difficult to understand. As Jack Bogle once said, “investors win; speculators lose.”
Featured Image Credit: Photo by Liza Summer; Pexels; Thank you!
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