Remembering that indices routinely fall into bear markets can help you cope with difficult times, but be careful: saying “it will come back” is not an investment strategy, says DataTrek Research.
Yes, indices such as the S&P 500 do always come back at some point, but there’s “no such guarantee for individual stocks”, many of which never regain their former glory. The same point is made by Behavioural Investment blogger Joe Wiggins: namely that some losses will not be temporary.
Poor investment decisions are exposed in bear markets. “Inappropriate leverage, unnecessary concentration and eye-watering valuations,” says Wiggins, “tend to bring about permanent losses of capital that time will not heal.”
This danger is more real than one might think. An old JP Morgan report shows that, since 1980, 40 per cent of US stocks suffered a “catastrophic” share price decline of 70 per cent or more. These were not temporary affairs but “large, permanent declines that were not subsequently recovered”.
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Stock markets invariably recover, but many stocks don’t. That’s why adding to a losing position in an individual stock in order to lower your break-even point isn’t good investing – it’s high-risk gambling.
