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Market sell-off - What to do?

1. Understanding Market Downturns

What is a market downturn?

A market downturn, also known as a correction or bear market depending on its severity, is a significant and sustained decline in the prices of financial assets, including stocks, bonds, or other investment instruments. In general terms:

  • Correction: a drop between 10% and 20% from recent highs.
  • Bear market: a decline of more than 20% over an extended period.

This phenomenon is a natural phase of market cycles and should not be seen as a terminal collapse, but rather as an adjustment influenced by multiple economic and psychological factors.

2. Common Causes of a Bear Market

Economic and systemic factors:

  • Economic recessions: when a country's GDP declines for two consecutive quarters.
  • Rising interest rates: make credit more expensive, reducing consumption and investment.
  • High inflation: erodes purchasing power and reduces corporate margins.
  • Financial or banking crises: such as the collapse of systemic institutions (e.g., Lehman Brothers in 2008).
  • Geopolitical factors: wars, economic sanctions, or political instability.

Psychological and behavioral factors:

  • Widespread panic: investors sell en masse, accelerating the downturn.
  • Contagion effect: problems in one market quickly spread to others.

3. Average Duration and Historical Depth of Declines

The duration of bear markets varies but historically lasts between 9 and 18 months.
The average decline during bear markets is around 30%, although it can exceed 50% during severe crises, such as in 2008.
Statistics from the S&P 500 show that since 1929, bear markets have been followed by prolonged and significant recoveries.

4. Investor Psychology During Downturns

The emotional cycle of investors:

Investors typically go through several emotional stages:

  • Euphoria: after prolonged gains.
  • Denial: when the downturn starts.
  • Fear: as losses deepen.
  • Panic: mass sell-offs and sharp declines.
  • Depression: feelings of failure and distrust.
  • Hope: after stabilization.
  • Optimism: when recovery becomes evident.

Cognitive biases that intensify during bear markets:

❌ Loss aversion: preferring to avoid a loss rather than achieve a similar gain.

❌ Confirmation bias: seeking information that reinforces fear.

❌ Herding behavior: following the crowd without independent analysis.

❌ Overconfidence: underestimating actual risks at the beginning of the downturn.

How to avoid irrational decisions:

✅ Establish a plan before the downturn.

✅ Automate investments and rebalancing.

✅ Consult historical data instead of relying on emotions.

✅ Maintain a long-term perspective and seek professional advice.

5. Building a Financial Safety Net

Definition of a safety net:
A set of financial measures designed to protect investors against severe market downturns and enable them to maintain their long-term investment plan without liquidating positions during unfavorable times.

Basic components:

✅ Diversification: spreading capital across various asset classes (stocks, bonds, real estate, cash, etc.).

✅ Liquidity: holding cash or assets that can be quickly converted to cash without significant losses.

✅ Time horizon: understanding that long-term investments better withstand volatility.

How to adjust the net according to your risk profile:

  • Conservative investors: more liquidity and fixed income.
  • Moderate investors: balance between fixed income, equities, and liquidity.
  • Aggressive investors: greater exposure to equities and smaller liquidity reserves, always with an emergency fund.

6. Emergency Fund: Your First Line of Defense

What is an emergency fund and why is it crucial:
It is a cash reserve set aside to cover essential expenses during periods of crisis or income loss. It prevents investors from having to liquidate investments at the worst possible time.

How to calculate the optimal fund size:

  • Minimum recommended: between 3 and 6 months of basic expenses.
  • For conservative profiles or unstable incomes, it can be extended up to 12 months.

Differences between an emergency fund and investment liquidity:

  • Emergency fund: not invested; kept in highly accessible accounts.
  • Investment liquidity: part of the portfolio to seize investment opportunities or reduce volatility.

7. Designing a Strategic Plan for Bear Markets

Introduction to the contingency plan:
A plan that defines specific actions to protect wealth and identify opportunities during market downturns.

The importance of discipline and consistency:
Following the predefined strategy reduces the chance of making impulsive decisions.
Consistency prevents emotional deviations that could jeopardize financial goals.

Common strategies:

✅ Portfolio rebalancing: adjusting asset allocation to maintain the strategic mix.

✅ Consistent periodic investing (Dollar-Cost Averaging): investing fixed amounts at regular intervals regardless of market conditions.

✅ Sector rotation: shifting exposure toward defensive sectors (healthcare, consumer staples) during bear markets.

✅ Defensive investments and safe-haven assets: increasing positions in government bonds, gold, or other assets that tend to preserve value during crises.

Step-by-step example of a plan:

  • Maintain a 6-month emergency fund.
  • Automate monthly contributions.
  • Perform quarterly rebalancing.
  • Redirect part of the liquidity toward defensive sectors during critical phases.
  • Avoid selling assets without technical or fundamental analysis.

9.8. The Role of Long-Term Perspective and Patience

✅ Historical statistics: market recoveries:

      • The S&P 500 has recovered from all major downturns within 3 to 7 years in most cases.
      • The stock market has provided positive 10-year returns in over 90% of historical periods.

✅ How to stay focused on financial goals:

      • Regularly review and update the financial plan.
      • Set clear and measurable goals.

✅ The advantage of investors who don’t sell in panic:

      • Those who held their positions during the 2008 crisis managed to recover losses and achieve superior gains in the following decade.

10.9. Common Mistakes During a Downturn and How to Avoid Them

❌ Selling at the worst moment: Avoid liquidating assets during peak panic when prices have already fallen significantly.

❌ Lack of available liquidity: Not having an emergency fund forces investors to sell assets at a loss.

❌ Not reviewing or adapting the strategy to the new market reality: Ignoring that each economic cycle has unique characteristics.

❌ Forgetting the importance of comprehensive financial planning: Overlooking taxes, insurance, and other key wealth management aspects.

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