SMART MONEY: The Most Dangerous Words in Investing

By Brad Brain

Certainly, there is no shortage of gloomy economic headlines these days. The newspapers and magazines are full of dire predictions of impending doom.

Here’s one of my favourites: “It is a gloomy moment in the history of our country… The domestic economic situation is in chaos. Our dollar is weak throughout the world… It is a solemn moment. Of our troubles, no man can see the end.”

Wow. That is pretty solemn. “Of our troubles, no man can see the end.” Not much room for optimism there.

Whenever things get scary people think that its different this time. But its not.

We are not in a bear market now, but sooner or later we will be. And what you do about that is up to you.

Renowned industry veteran Nick Murrays says that there are really just four truths that you need to know about bear markets.

First, bear markets are a normal and natural part of a never-ending cycle. As long as the stock market follows the economy, and in the long-term that is the only thing that it can do, and as long as human nature doesn’t change, which it won’t, we will have bear markets.

The consequence of these things is that the stock market cycles around a constantly rising trend line. We have these cycles because people alternatively get too euphoric when times are good and too terrified when times aren’t as good. The trend line is the average of these excesses. In other words, bear markets are perfectly ordinary events, just as bull markets are.

The second truth to know is that, in addition to being ordinary, bear markets are essential to the long-term outperformance of the stock market. It’s because of bear markets that investors demand a risk premium on their stock investments. If stocks were not volatile, then their prices, and thus their returns, would be bid down to a GIC-type performance range. The reason that the long-term returns after inflation for stocks are three times that of bonds is because the market demands it to compensate for the volatility.

The third truth to know is that bear markets are as common as dirt. We have had fifteen of them since the end of the Second World War. We see a bear market roughly every five years. Nobody can tell you in advance when they will start, or when they will finish, but they average out to be about a 30 percent decline, and usually last about 15 or 16 months.

Here’s the fourth truth. Bear markets are always the temporary interruption of a permanent uptrend. Always.

When things get scary people tend to think this time its different. My point is that isn’t so, and as evidence I will bring us back to that famous quote “Of our troubles, no man can see the end.” The reason that I shared this particular quotation is because of its vintage. These words appeared in Harper’s Weekly in 1857.

It has been said that the four most dangerous words in investing are “This time is different.” All objections to these four truths of bear markets are based on the hypothesis that this time it’s different.

But this time it is not different. It never is.

You know what a bear market really is? It’s an extended period of time during which the people who think that this time it’s different sell all their commons stocks at prices that will never be seen again to people who understand that this time it’s never different.

You might see about fifteen or so of these multi-year bull and bear cycles during your investment lifetime. How you respond is up to you.

Brad Brain. CFP, R.F.P., CIM, TEP is a Certified Financial Planner in Fort St John, BC. This material is prepared for general circulation and may not reflect your individual financial circumstances. Brad can be reached at www.bradbrainfinancial.com.