How to Survive a Bear Market?

Bear markets are undoubtedly trying times for investors, so we've assembled the
following guidelines to help you manage your investments during the next market
downturn. 

Maintain your balance. Hold a mix of stocks, bonds, and cash
investments tailored to your objectives, time horizon, tolerance for risk,
and overall financial situation. Cash investments provide stability as well as
liquidity for financial emergencies, while bonds offer steady income and
can help dampen the swings in stock prices. Stocks have historically
provided the highest long-term returns and the best long-term protection
against inflation at the cost of greater price volatility. Periodically revisit
your investment portfolio and make adjustments as necessary to keep
your mix of assets in line with your goals. 

Keep an even keel. It's human nature, at the first sign of trouble, to
become nervous and want to revise your investment mix. Indeed, market
downswings can cause even the heartiest of investors to have second
thoughts. It pays, however, to remain focused on the long term. Take
solace in the wise words of Abraham Lincoln: "This, too, shall pass
away." While Mr. Lincoln wasn't talking about the financial markets, his
observation is nonetheless telling. The markets run in irregular cycles in
which good and bad markets come and go. Remember, too, that you're
most likely investing to achieve a long-term goal, not to avoid a short-term
loss. 

Continue investing regularly. If you invest regularly through an
automatic investment plan or a 401(k) plan, continue making
contributions. This strategy, commonly known as dollar-cost averaging,
enables you to put the market's natural volatility to work for you by
lowering the average price you pay for your fund shares. It also reduces
the risk of committing substantial assets at a time when the market is
considered "high." 

Note: Dollar-cost averaging calls for investing the same dollar amount at
regular intervals, regardless of whether stock or bond prices are rising or
falling. This investment method does not guarantee that your investments
will make a profit, nor does it protect you against losses when stock or
bond prices are falling. Also, before embarking on a dollar-cost averaging
strategy, you should consider whether you will be financially and
emotionally willing to continue investing during a long downturn in the
markets. 

Make gradual shifts (if necessary). Resist the temptation to
fundamentally alter your investment strategy simply because one
component of your program heads south. Most experts will tell you that
moving your money from stocks and bonds to more conservative
investments in hopes of avoiding a loss or finding a gain is seldom
successful. Note, too, that while investment vehicles such as bank deposit
accounts and certificates of deposit (CDs) safeguard you against
day-to-day fluctuations, they do little to preserve the spending power of
your assets over time.* If you are anxious about the proportion of your
program invested in stocks, consider gradually and modestly reducing
your stock holdings in small increments. 

Consider the tax consequences of selling. Many investors swore off
stocks after the 1973-1974 debacle - selling out their entire equity
holdings. Not only did these investors miss out on the market's eventual
rally, but they most likely incurred a tax liability in doing so. While it
should not be your sole consideration, evaluate the tax consequences of
your investment decisions. Given the tremendous advance in stock and
bond prices over the past 15 years, you may realize a significant capital
gain when you sell or exchange shares of a fund at a higher price than you
purchased them. Capital gains realized on shares held one year or less
(that is, short-term capital gains) are taxed at the same rate as ordinary
income—from 15% to 39.6%. Capital gains realized on shares held for
more than one year (that is, long-term capital gains) are subject to taxes at
either a 10% or 20% tax rate. Abandoning your stock or bond position in
response to a market downturn could result in a nasty tax surprise. 
Set realistic expectations. Each of the three major financial asset
classes has provided handsome average annual returns over the past
decade - 18.1% for stocks, 9.2% for bonds, and 5.6% for cash
investments. The past three years (1995 through 1997) were particularly
extraordinary with stocks returning from 23% to 37.6% and bonds
returning from 3.6% to 18.5%. It is easy for investors to assume that
the best projection of future returns is a replay of the recent past. We
believe that you should expect less generous returns in the years ahead. 
