Many investors have never experienced a long-lasting bear market. The most recent bear market of some duration occurred in 1987, when the Standard and Poors (S&P) 500 Stock Index lost 34 percent and took 19 months to recover. Since then, declines have been short-lived and many investors have become accustomed to seeing their portfolios increase regularly – at least until about a year ago when the bull market came to an end. Now we are in the midst of a severe bear market and many investors don’t know what to do. For many, fear has replaced greed as the primary motivator, and the future is frightening. No one knows if the market has bottomed out or how long it will take to recover losses.

While bear markets are painful, they also can be times of opportunity. Yes, the stock markets will recover! Furthermore, a bear market provides a good time to reflect on your investment plans and reassess your savings and investment strategies. Better times are ahead. We want to be sure that the irrational exuberance of the 90s does not change to irrational pessimism and we don’t want to allow fear to jeopardize our futures.

History Adds Perspective

A bear market is a period of time when the price of stocks, as measured by a stock market index, decreases in value by 20 percent or more without the interruption of a 20-percent gain. Looking back to the end of World War II, the S&P 500 has suffered through 10 bear markets lasting an average of 15 months. On average, the index declined 29 percent over a period of 15 months during these bear markets, and it took 19 months for the market to recoup its losses. Averages, however, are interesting but not necessarily a useful barometer for forecasting the future. After the 1973-1974 bear market, for example, it took the S&P 500 nearly six years to recover!

Predicting the recovery period for the current recession is very difficult and we don’t know if we have hit bottom yet. We do know, however, that the average annual return from the S&P 500 has been nearly 13 percent for the past 30 years, 16 percent yearly for the past 20 years and at least 20 percent yearly from 1995-1999. Given the recent tremendous run up in stock prices (and especially for the NASDAQ), it may take some time for the various markets to recover to their previous highs. But the bull has always reemerged, and there is no reason to believe this bear will not be followed by another bull.

Waiting for the Next Bull Market

With the market in the doldrums, what actions should you consider taking? First, let’s consider what not to do. Don’t stop purchasing stock mutual funds as a part of your 401(k), 403(b) or IRA plans. With stock prices low, this is a time to stay the course. Continuing to make regular pension contributions allows you to dollar cost average. That is, you can purchase more mutual fund shares now for the same number of dollars required to purchase fewer shares last year this time. For long-term investors, a bear market can provide excellent investment opportunities. Remember that a low market is a time to buy.

Another potential pitfall is purchasing bonds or bond mutual funds. The reason is that interest rates are currently very low. When the rates go up again (and they will), bond prices will tumble. If you elect to invest in bonds consider those with relatively short maturities (five years or less) since these will be less affected by interest rate changes.

A third potential pitfall is investing in actively managed stock mutual funds. Most people who invested in these funds saw their values tumble during 2000 at the same time they produced significant taxable capital gains taxes – the worst of scenarios! By contrast, index funds produced negligible capital gains and they generally outperform actively managed funds.

On the “to do” list, now is the time to reconsider your priorities. If you have any extra funds, this is a good time to reduce your mortgage – even if it has a low interest rate. Paying down your mortgage represents essentially risk-free investing that will provide you with a more secure base for the future. Similarly, eliminate credit card debt. Make sure you have a rainy-day account equal to about three months take-home pay tucked away in CDs or other low-risk investments. Finally, if you have stocks that are dogs consider taking the losses. If the result of your securities transactions is a loss, you may deduct $3,000 of that loss in 2001 and any additional losses may be carried forward.

The information and planning ideas contained in this article are for general use only. The article does not cover all tax changes. Therefore, the ideas presented here should be relied upon only when coordinated with professional tax advice.