A valuable lesson my dad taught me was: “you have to be wary of the first shiny thing that comes your way. If you bite on it too fast, you may soon realize that there’s a hook attached to it.” Being wary of a rise in the market in the face of negative news is just as important as remaining vigilant when the market rises in the face of great news. When the market rises 20% from recent lows, it enters a bull market. This is a time of optimism for investors, who are willing to pay higher prices for securities. This optimism is driven by a number of factors, including economic growth and the belief that the market will continue to rise. On the other hand, bear market territory is often defined by a 20% drop from the recent highs, and along with this, investor sentiment is pessimistic. The willingness to sell at low prices, to preserve what’s left, increases. These mass selloffs can accelerate declines and drive prices even lower. This will also be a time when some companies check their vitals and cut costs where they deem necessary.
Bubbles occur in a bull market when this aforementioned rapid growth is not supported by fundamental economic factors and is instead purported on speculation. Investors react to this speculation and get set on the hunt well after it’s begun, seeking greener pastures. While the grass may be greener, the water bill is almost always higher. Once a stock hits that big jump, you have more often than not missed the train, and it’s better to dive into the fundamentals to see where your money is better suited to go. Bubbles burst, and when they do, they can lead to bear markets due to investors selling their shares to preserve what’s left. Sound familiar? Don’t get caught reaching for the shiny objects; inspect for hooks.
During a bear market, diversification in strong dividend-paying companies could be a way to pull your parachute and land softly. Companies with strong finances can weather any storm, and consistent dividend payments and dividend growth are good ways to have a visual of a company’s financial health. Diversification allows your portfolio to weather the storm because not all securities react the same in bear markets, so you can make up ground in one sector and re-evaluate your position in another at the same time. In a bull market, you will see strong companies continue to do what they do best, but you must be wary of their growth as well. Are their financials looking healthier or is there one product in their rolodex that has skyrocketed visibility in headlines? Knowing why you own a security will help you make the decision to either sell on the upside or “buy the dip” because you know that they will bounce back.
Having a financial plan in place will help you weather these storms and not fall into traps. Staying calm and focused, both in the face of decline and growth can determine your future financial health. Bull markets and bear markets are natural and necessary for healthy long-term economic growth, and knowing how to navigate them is not a one-man job.