Bear markets and financial planning

A monthly business column by a Mercer Island financial adviser.

By Robert Toomey

Special to the Reporter

Most people are aware that the stock market has recently experienced what is referred to as a “bear” market. This term refers to a decline in the market of 20% or more. This most recent bear market has declined by about 35%.

Since 1948, there have been 14 bear markets that have experienced an average decline of about 32%. Bear markets occur periodically and are usually associated with a perturbationin the economy or financial markets that results in reduced expectations for corporate profits. The coronavirus event will most definitely have a material impact on the economy and corporate profits and investors are discounting this through lower stock prices.

So what does a discussion of bear markets have to do with financial planning? The primary job for a financial planner is to provide the client with objective advice as to the best manner, or “plan” for the client to successfully achieve his/her financial goals. These goals can be for retirement, education, estate planning, “peace of mind”, or really any goal that involves the utilization of a client’s financial resources, both income and capital.

Financial plans usually include an investment strategy that the planner believes is the optimal strategy for enabling the client to achieve their goals. This strategy most often will include a recommended asset allocation of both stocks and bonds. Therefore, trends and assumptions for financial market returns can and will have an impact on expected future financial resources.

A plan’s investment strategy is usually matched to the duration of the planning period, which for most people is decades. The measures we use to assess the strength of a financial plan take into account both projected market returns and volatility of returns over long periods of time (which includes bear markets).

History has shown that portfolios that are allocated between both stocks and bonds not only reduce risk (volatility) compared to an all stock portfolio, but also allow for a faster recovery of capital when markets recover. As an example, looking back over the past 70 years, while rolling 12-month stock returns have varied widely both positive and negative, a 50/50 blended portfolio of stocks and bonds did not suffer a negative return during any rolling 20-year period. This is important because it shows that diversification works in preserving capital over the long term and thereby increases the likelihood of the success of a financial plan.

So, coming full circle, how does a bear market like we are in now affect financial planners and our clients? In terms of the plan itself, not at all, really. We know bear markets happen periodically and this volatility is reflected in a financial plan’s assumptions. A client should not be overly concerned about a bear market as long as the client’s plan is grounded in sound assumptions, their investment strategy is appropriate, and the client remains disciplined in adhering to the plan over the long term.

Robert Toomey, CFA/CFP, is vice president of research at S.R. Schill and Associates on Mercer Island.


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