Wednesday, September 24, 2008

Three Strategies for Dealing with a Bear Market

The other day I got into an interesting discussion with some colleagues at work, that showed me how diverse people's reactions to the stock bear market can be. First, was our CFO who has a cut and dried strategy: "don't buy on the way down". Our Director of Sales pursues a different course of action: he has taken 50% of his assets out of the market, and left 50% invested. Then there is me.

My philosophy is different. I invest every month - on the 15th of the month. If the stock market is closed on the 15th, I invest on the next business day. The amount of money I invest every month is identical, and does not change with market conditions. I invest our cash in a way that counteracts the volatility in the market, such that our asset allocation doesn't shift too much. For example, over the past year, as real estate stocks took a tumble, I have been putting more money into that sector to maintain about 8% of our investments in that asset class. So far, these new investments are under water, but I don't sweat it. This is not money that I need right now, so I really don't care what it does day to day. I only care what it will do over the next 25 years... Well, to be perfectly honest, that's not an accurate statement. I won't tell you that I am not nervous on days when the market takes a nose dive, but I sit tight, and don't let those swings interfere with my long term strategy.

My colleagues' strategies are faulty in my opinion. My CFO suggests that one should not buy stocks in a bear market. When I asked him how he knows when it is safe to dive back into the market, his reply was that he looks for something fundamental to change. The problem is, in my opinion, that by the time he thinks something fundamental has changed, he may have missed the biggest portion of the upward correction. His strategy seems guaranteed to insure that he only buys assets when they are fully priced or even over priced. Our sales guy, on the other hand, has taken a more rational strategy. It's not that he is not invested, he simply reduced his exposure to the market. Perhaps he is uncomfortable with large swings in his portfolio value. I understand his approach, but that too seems sub-optimal if you are thinking long term

In short, I strive to make investing as boring as possible. I don't try to game the system, forecast swings and changes in the market or get outsized returns. If my investments generate the market average returns I am very happy with that result. I am no Warren Buffet and neither are most other people... Time will tell how are differeing strategies will fare in the current crisis. 

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