This is an extremely important question for any index investor, and any investor in general of course.
And this is a very relevant question today because the stock market is down 20% in the US and about 10% globally today compared to the beginning of the year.
Following COVID and now with the war in Ukraine, the world economy has slowed down. Inflation is breaking records in many countries and there are talks of an upcoming recession in most news media.
While falling stock market prices is a great opportunity for long term investors like us, it’s still hard to handle the uncertainty. It’s hard to invest when the overall expectation seems to be that it is going to continue to go down. It is especially hard for beginner investors, like the students who took my course in the past few months and only started investing recently.
Interview with Rick Ferri on how to invest during bear markets
To help them manage their emotions and overcome these uncertainties, I invited one of the very best people on earth to talk to us about how to invest in bear markets: Rick Ferri.
Rick Ferri is the president of the The John C. Bogle Center for Financial Literacy and host of the “Bogleheads on Investing” podcast.
He has been a financial advisor for 35 years and a pioneer of low cost investing via index mutual funds and ETFs, and low-fee investment advice and portfolio management.
He is the author of 7 investment books (including one of my favorites “All About Asset Allocation”) and hundreds of articles. Published in Forbes, the Wall Street Journal and professional journals.
He has helped thousands of index investors navigate uncertain times like the one we’re going through now.
The conversation was really insightful and it had an incredible impact on the audience.
Most of the fears and uncertainty attendees had before the event were dissipated by the no-nonsense and very clear approach of Rick.
All of us left the event with a reinforced mindset that will help us get through these uncertain times successfully.
The conversation was so good that I decided to also release it on the podcast so that the entire community can benefit from it.
Key insights from the interview
Here are some of the key takeaways from the conversation with Rick Ferri. But I highly recommend you listen to or watch the podcast episode because hearing this from him directly is very impactful.
Stock market investing: passive (index) vs. active
- Index investing is an evolution in the investment industry. The data on performance is clear and investors are gradually convinced of the power of index investing. Once an investor understands it, it’s impossible to go back and “unsee” it. So more and more people are learning about index investing and so it’s gaining ground, despite the entire financial industry trying to fight it (their fees and therefore their survival depends on people not knowing or doubting index investing)
- Index investing has been gaining ground, but there is still a long way to go. Today about 12-13% of the money in the US stock market is invested in index funds. Outside of the US that number is much much smaller. One key reason for that in other parts of the world retail investment is mostly controlled by banks, who have no interest in promoting index investing.
- The probability of active management outperforming is very low. Most of their returns are market returns anyway, and after increased costs and taxes they rarely do better than the market over the long term. It makes sense to simply buy the market and outperform the vast majority of active management.
What to do given the recent market drop?
- Market drops like we’ve been through in the first half of 2022 are amazing opportunities for people still contributing to their portfolio. Actually, you would want it to be a bear market for the next 20 years, so that you buy, buy, buy, buy, buy, buy, buy.
- The recent market drop is relatively insignificant. It’s back to the level of 1 or 2 years ago, so it’s not much really. And it should be expected. On average 1 year out of 3 at least we should expect the stock market to be down.
How to invest if you are close to retirement?
- For people closer to retirement, the advice is to have some money in short term bonds, so that you can be relaxed about having funds for the first few years of retirement. You can also look at dividend distribution from your funds and use that as income (even with accumulating ETFs), and finally you should have a cash cushion for short term needs. A combination of these 3 is how you build stability for your pension. The rest should still be in stock index funds.
- Perfection is a curse. It’s impossible to find the perfect portfolio. Pick your asset allocation, whether it’s 50/50 or 80/20 that’s fine, and then stick to the plan. What’s important is to have a simple plan and to stick to the plan. It’s useless to try to time the market, it’s simply going to hurt you. Stick to the plan. Investing is simple. Build a plan, and stick to your plan.
Are bonds still good investments?
- Bonds are a self-writing asset class. As bonds mature they simply deliver what they promised, which is the capital + the interest rate. That’s it. And bond funds simply replace maturing bonds with new ones, rolling the money over into new bonds. You can’t lose money in bonds as long as you hold them to maturity, unless they’re junk bonds (but we don’t invest in those). When interest rates go up, yes bond valuation may go down, but if you hold to maturity, you just get you capital back + interest, and the new bonds in the fund have higher interest.
- You need bonds in your portfolio because they are not stocks. When the stock market goes down 40%, 50%, 60% it does not feel good. And most people can’t handle and sell. Bonds are there to protect you from that.
Here is all you need to be a successful index investor:
- Philosophy: I’m investing in low cost index funds because I know that’s the way to get better performance than 90%+ of active managers
- Strategy: what’s your portfolio, how do you invest, how much and when? This is your personal plan
- Implementation and discipline, staying the course: maintain the philosophy and implement the plan
That’s all you need.
Once again, I highly recommend you listen to the conversation because it is much much powerful to hear it from Rick Ferri than to quickly skim through a few bullet points.
How to start index investing in Belgium?
And if you’re new to index investing or if you’re struggling to build your investing plan and implement it, then watch my free workshop on index investing for beginners. In the workshop I help people overcome those obstacles, I provide a roadmap to get started and I offer support for the implementation for those of you who need help. Check it out!