As many as 15% of today’s retail investors may have never experienced a bear market. Indeed, more than one in seven investors only started buying and selling shares last year. This means that a large proportion of them may only have experienced large profits derived from the stock market’s recent surge to reach a record level. The thought of losing money on shares may seem rather distant, or even far-fetched, to them.
However, the prospect of capital loss is a very real threat to all investors. The stock market’s track record shows that share prices can fall dramatically in a short space of time. Indeed, there have been 26 bear markets since 1928. All of them may have seemed obvious after the event, but none of them came with a warning to investors to sell shares prior to their occurrence. As such, the next correction or bear market may be equally unpredictable to all investors.
An opportunity to benefit
Of course, all of those 26 bear markets have been followed by bull markets. And, as mentioned, the stock market recently reached a record high. As such, investors who have hung on to a diverse range of high-quality stocks throughout difficult periods for the stock market have generally enjoyed relatively attractive returns over the long run.
The difficulty, though, is continuing to hold shares that are falling in value. Even more challenging for many investors is the task of buying more stocks during periods of decline. However, it is during such periods when the most attractive buying opportunities often present themselves. Indeed, high-quality stocks can temporarily trade at prices that are significantly below their intrinsic values while investor sentiment is weak and fear is high.
As such, the prospect of a slump in stock prices should not cause fear among any investor. Rather, bear markets should be welcomed because they provide an opportunity to buy assets for less than they are worth. A subsequent recovery is very likely according to the stock market’s track record.
A logical mindset
Despite this, many investors may balk at the idea that a large stock market decline presents an opportunity. This viewpoint may be particularly commonplace among newer investors who have not experienced bear markets and their subsequent recoveries.
In my view, investors who cannot adopt such a mindset could struggle to benefit from the stock market’s long-term growth potential. They may be scared out of stocks during periods of significant declines in a short space of time. Conversely, they may only purchase stocks when the future seems bright and valuations lack margins of safety. This may limit their capacity to generate high long-term returns.
Indeed, Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) Chairman Warren Buffett (Trades, Portfolio) has previously discussed whether the stock market is a suitable place for everyone to invest. As he once said: “You shouldn’t own common stocks if a 50% decrease in their value in a short period of time would cause you acute distress.”
Since 1928, there have been three bear markets in which the stock market declined by 50% or more from peak to trough. They occurred in 1931, 1937 and 2007. The next one will be impossible to predict, but is very likely to occur at some point in the future. Investors who can embrace it and use it to their advantage could enjoy significant returns in the long run. Those who feel they could not do likewise may wish to reconsider their asset allocations while the stock market currently trades close to a record high.
