Surviving natural disasters requires preparation and a cool head. Surviving the onslaught of a bear market requires similar skills.
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When disaster hits, Joshua Piven and David Borgenicht are there to help. Their book, The Worst-Case Scenario Survival Handbook, offers pithy and useful advice to help us survive all sorts of catastrophes.
Let's say you're floating off the coast of Oahu, minding your own business, when you're abruptly attacked by a tiger shark looking for lunch. According to Piven and Borgenicht, the best course of action is to strike back at the eyes and the gills, not the nose. Or if caught unexpectedly in an alpine avalanche, try to stay on top of the snow by using a freestyle swimming motion. If by chance you get buried, use your spit to determine which way is up, and dig like mad.
Here are a few more pointers from The Survival Handbook for those taking adventure vacations this summer -- just in case that trip turns into a little too much adventure, and not enough vacation:
Even though The Worst-Case Scenario Survival Handbook gives guidance on how to survive 40 different disasters, I found it lacking in pertinent advice for Foolish investors. The chapter "How to Deal with a Charging Bull" looked promising, but didn't even mention the remarkable market run we've seen this past decade. That section dealt more with livestock, rather than live stocks.
Finally I turned to the chapter "How to Escape From a Bear," hoping to learn about dealing with declining markets. I was disappointed yet again. (I did learn that it's best to initially lie very still during ursine encounters, but if attacked go for the eyes and snout.)
Since I couldn't find any financial words of wisdom, I've decided to write my own chapter on dealing with market calamities. Just what should we do in a worst-case scenario involving our stocks? How should we act during a market meltdown?
How to Survive When Your Portfolio Drops 40%
Do nothing.
[End of Chapter]
That's right, do nothing. If you've truly invested Foolishly, followed the 13 Steps, and invested for the long-term, a market meltdown shouldn't cause alarm. It's an event we should expect to occur. As such, it's perhaps one of the few disaster scenarios that calls for inaction rather than frenzied activity.
The rationale underlying the recommendation for inertia is pretty simple. At any one point in time -- whether the market is doing well or isn't -- we can't predict the future direction for stock prices. Once a market drops 40% or so, it's as likely to rise significantly from there as fall significantly. The same goes for a market that's dropped 10%, 20%, or even one that's risen 50%.
After a significant market fall, the damage has already been done. Panic selling assures you a loss, possibly at the exact wrong time. Sure, it would have been ideal to have foreseen a crash and sold everything until the market hit its low point, then bought back in. But let's repeat the Foolish Mantra:
No one has ever consistently predicted short-term market movements.
No one has ever consistently predicted short-term market movements.
No one has ever consistently predicted short-term market movements.
When disaster strikes, practitioners of mechanical investing strategies like the Foolish Four or Beating the S&P have it easier than most investors. The rules of these strategies dictate inaction, no matter how counterintuitive it seems. We just buy our stocks, hold for a year (and a day), and then trade in stocks for another year. It's the Rip Van Winkle approach.
For those who adamantly insist on doing something when their Foolish portfolio has plummeted, I'd recommend examining this poster, or even buying it. It shows the Dow Jones Industrial Average for the past 100 years or so, along with important economic and historical events.
Imagine yourself in any one of those innumerable trenches during a market tumble. In the short-term scenarios, when viewed from close up, the drops look gigantic. But keep an eye on the long-term picture, in the bottom part of the poster. In the long run, it's always been up, up, and away. As opposed to making a mountain out of a molehill, the long-term perspective prevents you from seeing a Grand Canyon when there's really only a small gully.
The Worst-Case Scenario Survival Handbook stresses time and again that preparing for potential disasters is the best way to mitigate them. Pack your parachute carefully. Walk with a pole in quicksand territory. Avoid walking in the mountains when conditions dictate avalanches are likely to occur, or carry an avalanche probe if you must.
Preparation can also help to minimize the inevitable pain caused by worst-case financial disasters. Foolish investors should know these rules by heart, but they bear repeating:
Most importantly, expect the value of your portfolio to drop significantly at times. By proper preparation, we can learn to deal with earthquakes, sinking cars, alligators, and even hostile gunfire. In comparison, a bear market may seem almost welcome!
Beating the S&P year-to-date returns
(as of 07-11-00):
Bank One <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ONE)") else Response.Write("(NYSE: ONE)") end if %> -3.6%
PepsiCo <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PEP)") else Response.Write("(NYSE: PEP)") end if %> +16.0%
Ford Motor Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: F)") else Response.Write("(NYSE: F)") end if %> -5.1%*
Bank of America <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BAC)") else Response.Write("(NYSE: BAC)") end if %> -4.5%
Fannie Mae <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FNM)") else Response.Write("(NYSE: FNM)") end if %> -5.0%
Beating the S&P -0.4%
Standard & Poor's 500 Index +0.8%
*Includes Visteon <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: VC)") else Response.Write("(NYSE: VC)") end if %> spin-off
Compound Annual Growth Rate from 1-2-87:
Beating the S&P +23.2%
S&P 500 +17.3%
$10,000 invested on 1-2-87 now equals:
Beating the S&P $167,700
S&P 500 $86,200
