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What should you do if we’re in a bear market?

You already know the world’s stock markets are down in the dumps.
 
Since October, equities haven’t got a break. The market rallies for a few days, only to slump again. You put new money to work – ‘buying the dips’ as the traders say – but these dips have hidden depths.
 
So you lose yet more money to the slide.
 
Where will it end?

Stay on target

You probably won’t be surprised to hear I can’t answer that question.
 
I’ve been investing for too long to trust – let alone give – guesses about whether we are in a bear market that will see shares fall another 10, 20 or even 50%.
 
And we should all ignore the pundits who claim they can read the market’s tealeaves that supposedly signal when the worst is past.
 
I’ve never found one with a track record that usefully stands up to scrutiny.
 
Standard Motley Fool advice is therefore to keep your spirits up, recall that shares on sale are like bargains at the shops – and remember if you’re investing and compounding your wealth for 20 years or more, lower prices are a boon.
 
That’s our standard advice because it’s the best advice. 
 
After all, most of us are saving for retirement. The less we pay for the shares that make up our retirement pots, the greater the potential long-term gains.
 
Today’s miserable portfolio full of red should someday pay for tomorrow’s holiday in the sun.
 
When you see slumps in this light, it’s hard to stop yourself buying more shares when prices fall!
 
But the other reason why sticking to your long-term plan is sensible is because even if you wanted to chop and change your portfolio when markets get wobbly – selling before declines and buying before a bounce back – the odds are stacked against you.
 
Few great investing track records were built this way. The future is uncertain. So wise stock pickers focus on company fundamentals, and let their businesses take care of the rest. Over-trading is more likely to make your broker richer than you. 

But…

Having said all that I am now going to tell you when you might want to sell some shares when the market is down!
 
Do I contradict myself?
 
Not quite.
 
Here are five times when it can make sense:

1. You realise you’re more risk averse than you thought

 There’s an old saying that everyone is a genius in a bull market. It doesn’t take bravery to be invested when shares go up every week – but a lack of imagination helps! If you had more money in equities than you should have because you didn’t really think about prices falling, it may be best to find a more sensible split between shares, bonds, and cash before things potentially get worse. 

2. You’re invested in mediocre companies you don’t believe in

Discipline can go out the window in a long bull market. Investors may end up with portfolios of shares they’ve selected not as a result of proper research but through tips, hunches, buying hot stocks, and the last science-fiction movie they saw. To be calm through a bear market, it’s best to believe in the firms you own. If you’re holding bad companies you wouldn’t buy today it may be best to sell, even if prices are already down from the highs.

3. You own too many expensive-looking companies

This is similar to the last point, but trickier. Multiples such as P/E ratings can soar in a bull market. The most exciting growth stocks can become absurdly expensive. Yet such valuations can be the hardest hit in less optimistic times. I say it’s trickier because the very best companies often look expensive, yet over the long-term they can still deliver stellar gains – and also because the de-rating of high multiples can occur before you’ve noticed what’s going on. US tech giants for instance now look fairly priced to me, after two months of declines.

4. Your portfolio is worryingly unbalanced

Market indices that climb over the years are deceiving – it’s usually only relatively few stocks that drive most of the gains. If you own some of these companies pat yourself on the back, but pay attention to how their success may leave you exposed in difficult times. What percentage of your portfolio you should invest in any one company is up to you. (Personally I get nervous at allocations above 10%.)

5. Your situation has changed and you weren’t paying attention

Rising stock markets are a wonderful aid to getting to where you want to go financially, as long as you’ve been invested enough to benefit, of course. However as your retirement day draws nearer – or the school fees approach, or you’re ready to buy that holiday home, or whatever else you’re invested in shares for – an outsized exposure to equities can be dangerous to your wealth. As we age we have less time to recover from setbacks. An aggressively high allocation to shares that made sense when you were 30 or 40 may be reckless when you’re 60 or 70. If it’s taken a stock market slide for you to accept time moving on, well, you’re only human. But consider acting now to dial down your exposure, in case life-changing falls you won’t have time to recover from are just around the corner. 

Be thoughtful when others are fearful

It’s never a good idea to start dumping shares in a panic because you think the market is telling you something useful just because prices decline.
 
Markets go up and down – always have, always will – and we should know this when we start investing. A bout of falling prices isn’t telling us anything new.
 
However what such falls may reveal is something about you or your portfolio – something you didn’t realise when ever higher prices papered over the flaws and made everything look rosy.
 
If that’s the case, then it may indeed be prudent to act now, rather than just hope things turn out for the best.

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