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Why a Bear Market Is a Young Investor's Best Friend

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If you've got time on your side, there's a real silver lining here.

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Young investors, meet the bear market. Now embrace it.

If you are an investor with at least a 30-year time horizon, you should be celebrating the stock slump, according to a new study from T. Rowe Price (TROW). Analysts at the Baltimore, Maryland-based firm acknowledge that the historically poor performance of equities in the last decade might have spooked some greenhorns into changing up their investment game plans: youngsters might have decided to cut back or even eliminate their exposure to stocks.

But that's a move they may come to regret. Instead of backing off from stocks, they might want to consider being more aggressive.

Bear markets provide a real advantage for investors that are decades away from retirement. Authors of the study write that those who began systematically investing in equities in past severe bear markets were significantly better off 30 years later than investors who began in bull markets.

"There is a real silver lining here," says Christine Fahlund, a senior financial planner at T. Rowe that worked on the study. "Young investors need to understand that market cycles have different benefits for different age groups at different times. When markets are down, and you're a young investor, it's an excellent opportunity."

Fahlund says young investors have two powerful forces working in their favor: the cyclicality of the markets and the ability to accumulate a lot of shares early in their career, putting them in a stronger position to gain from future bull markets.

The new analysis examined four hypothetical investors who each contributed $500 per month into a retirement portfolio that replicated the S&P 500 Index over a 30-year period. The study compared investment performance between two investors that began making contributions in 1929 and 1970, just before two terrible bear markets, with two investors that began putting money to work in 1950 and 1979, right on the verge of two of the most rewarding decades in the stock market.

The result: those investors that started making contributions in 1929 and 1970 had ending account balances that were more than double those of the two investors who began making contributing at the start of decades with strong bull markets, in 1950 and 1979.

An investor that started investing in 1929, after 30 years, ended up with a total return of 960% while the investor who started in 1970 had a total return of 1,753%. Investors who started contributing in 1950 and 1979, on the other hand, earned less than 400% during the three decades.

"Bear markets are your friend, when you're young," says Fahlund. The financial planner advises young investors, meaning folks between the ages of 20 to 40, to live within their means, save, and invest systematically. They should have 80% in equities, with at least 15% of their salary dedicated, year in and year out, to building that nest egg.

Other market pros broadly agree with T. Rowe's analysis provided that investors understood a few important caveats.

Vitaliy Katsenelson is a vice president and portfolio manager with Investment Management Associates, a private portfolio management firm based in Denver, Colorado. "If your time horizon is 30 years away then it's always a good time to invest," Katsenelson says. "But, within the next 5 or 10 years, your returns might not be that great."

In fact, Katsenelson believes that stocks will likely trade in a narrow range for the next several years and relying exclusively on a buy-and-hold approach won't work. An investor who imagines he's going to enjoy some 7% real rate of return from sitting on a passive portfolio is in for a rude awakening, he says.

The larger problem for young investors then might be that they get discouraged over the next 10 years from lackluster returns and decide to bail.

"Even if a young investor has a 30-year time horizon, they can't mentally deal with a portfolio that goes nowhere for 10 years," Katsenelson says. "People don't have that kind of patience. They get fed up with stocks."

So if you really want to see just how friendly a bear market can be, it takes not only time, cash, and courage, but also perseverance.
No positions in stocks mentioned.
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