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Can You Outrun the Bear?


Market timing only works for consistent prophets. Invest based on what you can't afford to lose rather than what you hope to gain.

"I've just moved my retirement portfolio into cash," my friend told me late last week.

Like millions of folks, he was tired of the market's pernicious volatility and wanted to play it safe.
Cash always sounds like a safe haven if you want to protect your money. Yet for many, it rears the ugly head of a dangerous beast: market timing. This technique rarely works consistently, even for the pros.

First, let's not stay in denial about the safety of the stock market. There isn't any. It always posed risks, returns aren't guaranteed, and you're unlikely to know when the next crisis will occur.

Uncertainty is compounded with some serious problems in the global economy now. The US is still struggling with unemployment, a housing crisis, and the fallout from the ongoing European debt meltdown.

Is another bear market imminent? You'd be justified in fearing the impact of a prolonged downturn, which could be set off by a double-dip recession in the US or other crises abroad.

According to research from Standard & Poor's Sam Stovall, from Dec. 31, 1945, through May 21, 2010, the S&P 500 fell in 46% of all trading days. The index has dropped 2% or more an average of five times a year in that period.

So much for Wall Street's conventional wisdom that the market generally goes up.

There are different degrees of downturns, so not every dip triggers a bona fide bull market. This is how the S&P looks at declines:

  • Pullbacks. This is when the market is down from 5% to under 10%. There have been 53 of these events since 1946 (through May 21).

  • Corrections. These are more serious dips, measuring from 10% to 20%. S&P has recorded 18 of these in the post-War period.

  • Bears. These 12 growlers have seen stocks retreat 20% or more.

What's important to take away from these declines is that the market is ever dynamic.

When it came to the corrections -- which averaged 14% declines -- recovery took about four months to push the S&P average back to pre-correction levels. And there's always more to the story since the market may hit another correction or go into a bull mode.

"History is a great guide, but it is never gospel," writes Stovall, "and averages only hint at the whole picture."

Taking a look at rebounds is also informative. In 17 corrections, since the end of World War II, 15 posted additional gains after reaching breakeven points.

You can also never take these market retreats out of context. Recessions and inflation are rarely good for stocks. The "stagflation" that combined inflation with almost no economic growth was the bane of the 1970s.

Even when interest rates are relatively low -- as they have been for more than 20 years -- that doesn't stop massive speculation (dot-com and housing bubbles) or greedy bankers (we can't forget 2008).

With history always in the rearview mirror, how do we avoid getting burned by the next bear?

The first rule is one that so many ignore: Invest in the stock market money you can afford to lose.

Are you in or near retirement? Are you building a college savings fund that you will tap soon? Would a 10% correction hurt you? Would a 20% hit cripple you? Keep in mind that at certain ages, your earning power drops so you won't be able to save and invest your way back into another sweet spot.

Knowing the long-term risk of the market always begs this key question: Could you handle a major decline right before you retire or start paying tuition bills? If you can't, then cash, bonds, and inflation-protected securities should be a major holding in your portfolio.

Then there's the ultimate question of humility. Will you know exactly when the next bear will begin and end? Most people have no idea and few, if any, professionals guess right on this either.

If you don't have the gift of prophecy, then go with your worst fears. Invest based on what you can't afford to lose rather than what you hope to gain. That's the safest bet.

John F. Wasik is author of The Cul-de-Sac Syndrome: Turning Around the Unsustainable American Dream.

New to investing? E*Trade can help. Click here to watch a series of brief educational videos like "New to Online Investing," "The Basics of Stock Screening," "Options for Beginners," and more.

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No positions in stocks mentioned.

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