Bear markets bring about increased risk but perhaps not in the way we might think. Sharp declines in equity markets create incredibly high levels of behavioural risk. The chances of us making decisions which compromise our long-run outcomes are incredibly high. There is no easy answer to coping with such spells – they are a challenge for us all – but there are some important things to remember:

Significant market declines always come with very bad news about the future:

It may seem obvious but is often ignored – large falls in equity markets come because of meaningful fears and uncertainty about the future. The specific cause of these will be different on each occasion. Markets don’t just drop, they drop for a reason and that reason will create profound worry.

This is why people who talk about waiting for ‘better prices’ to invest in equity markets probably never do – because those better prices arrive with bad news, news that makes us not want to invest. Everything will feel bad during a bear market, if it didn’t we wouldn’t be in one.  

Risk is not a theoretical concept – it is about how we feel:

Living through a 30% decline in equity markets is an entirely different proposition to looking at a theoretical loss on paper. We might know that equities can fall a lot in the short-term, but we won’t truly understand what that means until we feel it. We are far more likely to insure our house against flood risk after it has flooded – risk often only becomes real when we have experienced it.  

When we are living through market turbulence our appetite for risk will inevitably start to wane. Bear markets take a heavy emotional toll and can cause profound anxiety. Even well-adjusted and disciplined investors will be vulnerable because the longer and more pronounced the decline, the greater the chance that we start to question our own investment principles.

Reassessing our investment approach in a bear market is probably a bad idea:

It is often suggested that reviewing our investment approach during sharp equity market sell-offs is prudent. I understand the idea – confirming we are still comfortable with our plan amidst stressed environment seems sensible – but we need to be very careful here. It is incredibly unlikely that we will make good long-term decisions during times of acute worry.

When we are feeling anxiety, our body wants us to do something about it – this usually means removing its cause. That is why so many investors move to cash when equity markets fall – it relieves the pressure we are feeling in the moment, whether it is likely to come with a long-term cost will not seem like an important consideration at the time.

During bear markets the attraction of overhauling our investment approach and turning it into something that makes us feel comfortable right now will be incredibly strong, but making decisions about the future when under immediate pressure is rarely a good idea.

It is probably best not to plan next year’s holiday when we are on a plane suffering
from severe turbulence as we will probably end up choosing somewhere very close to home.

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Our default assumption should be that decisions made during bear markets will be bad ones. Humans are designed to make certain types of choices under stress and few of these are aligned with good long-term investment thinking. This does not mean we should never do anything, but that we should exercise more caution than usual. The temptation to make choices that satisfy our current self at the expense of our future self will rarely be greater.

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My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).