5 Lessons From the Bear Market

5 Lessons From The Bear Market

One year ago, on March 23, the S&P 500 closed at its bear market low. Today, we are going to talk about 5  lessons we can learn from the bear market of 2020. 

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A year ago, on March 23, the stock market reached its bear market low caused by the COVID pandemic. Stock prices fell about 34%. Over the next 5 months, prices raced higher.

What are some of the lessons we can learn from going through this bear market? For some, it was their first bear market experience. For others, like me, it was not their first. (This was my fifth.) These experiences teach some great lessons. Here are 5 lessons from the bear market.

Bear Markets are a Temporary Interruption.

Bear markets are a temporary interruption to the permanent long-term advance of stocks. About one out of every five years, we see a significant decline in the stock market. It is a reset and a healthy adjustment. Once the stock market hits bottom, prices go on to recover and set new highs.

Since 1946, we have seen 14 bear markets. Every single one has recovered and created new wealth for those who are patient and continue investing in stocks. 

Most People Can't Outsmart the Market

It is virtually impossible for most people to outsmart the stock market. Did you think…

  • February 19, 2020 was going to be the current all-time high?
  • March 23, 2020 was going to be the bottom?
  • The stock market was going to recover as fast as it did?

I did not expect any of the above. I bought stocks two days before the market set the all-time high. We anticipated things to get worse before they got better. We thought that the shutdowns were going to cause even more damage to our investments than they did.

The stock market turned quickly and raced higher. The bear market ended in less than 6 months! We expected the recovery to take at least two years.

Many people try to guess the highs and lows. They look for points to sell and to buy. Doing this often leads to big mistakes, and those can impact your lifetime return.

Buying Stocks "On Sale" is Hard

Buying stocks in the middle of a bear market is very difficult. A year ago, many of these great businesses were trading at 30%, 40%, or 50% discounts. We had the opportunity to buy many of those stocks at prices we may never ever see again.

In the moment, you can say, “Stocks are low, buy now!” At the same time, the news tells you everything is bad and getting worse. How do you see the return potential in those moments? In the middle of a bear market, most people assume stocks are heading lower, and they are going to lose even more.

You Don't Lose Anything Until You Sell

We all looked at our accounts last year and watched the values sink. It was uncomfortable and unpleasant. It created a lot of stress. There is a natural reaction to want to sell when things are going bad. You want to protect what you have.

Until you make that sale, the decline is temporary. If you hold on to your investments, you will most likely recover from the decline.

Selling near market lows makes those temporary decreases in value permanent losses. It also makes erasing those losses very difficult.

A Bear Market is Always in Front of Us

Nobody knows when the next bear market will begin. We do not know how far prices will drop or how long it will last. Bear markets are a common occurrence in the stock market. On average, we see one happen every five years.

We hope it takes several years before we experience the next bear.  When it happens, we can use the lessons learned from our past experiences to make us all better investors.

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About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors.    He specializes in helping hard working, middle class families plan for retirement.

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10 Percent Doesn’t Mean 10 Percent

10 Percent Doesn't Necessarily Mean 10 Percent

When it comes to stocks, 10 percent doesn’t necessarily mean 10 percent. We will explain this and how setting reasonable expectations can make you a better investor.

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When young financial advisors go to financial advisor school, one of the first things they are taught is the stock market has an average annual return of 10% per year. This leads people to believe the stock part of their investments are going to improve by 10% each year. But, 10% doesn’t mean 10%.

Only two times in the last 96 years have we seen stocks return close to 10% in a calendar year (10.06% in 1993, and 10.88% in 2004). It is more likely the positive years are going to be much better. And, there will also be some negative years, too.

When you’re thinking about what could happen in any given year, you should expect anything. In the short term, almost anything is possible. But over a long period of time—20 or 30 years—expecting stocks to return 10% per year is reasonable.

Setting Reasonable Expectations

It helps to set reasonable expectations when you’re an investor. It helps you to understand volatility is part of the process. And, we also know there will be difficult periods you have to navigate.

For example, you should expect the stock market to be positive three out of every four years. And, you should anticipate one year in four will be negative. Those plus years are likely to be much better than the 10% average annual mark. The average up year is about 21%. The negative years average -13%.

Corrections

You should also expect corrections to happen at least once a year. (We may be in the middle of one right now.) The average correction is about -14%. But even with those interruptions, the market has continued to improve over time.

Bear Markets

You should also expect bear markets. We had one last year, and it was an awful experience. But, the stock market recovered, and the recovery happened a lot faster than any of us anticipated.

When we set reasonable expectations, we can make better decisions about our investments. It keeps us from selling at bad times. It may keep us from buying at bad times as well. Avoiding those key mistakes can help us improve our real-life returns.

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About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors.    He specializes in helping hard working, middle class families plan for retirement.

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How Can You Invest in Electric Vehicles?

How Can You Invest in Electric Vehicles?

How can you invest in electric vehicles? Today we discuss:

  • the two ways you can do this
  • the difference between the two
  • and a valuable lesson we can learn from one of the best-performing stocks over the last quarter-century, Amazon.

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How Can You Invest in Electric Vehicles

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How Can You Invest in Electric Vehicles?

This is a hot topic right now. More people are wanting to know how they can take part in this new and emerging technology.

Individual Stocks

The first way to invest in electric vehicles is to buy individual stocks. The most popular is Tesla. They have been making electric vehicles for a few years. The other major auto manufacturers are also getting involved in this. Both GM and Ford are committing billions of dollars to this technology. GM is also challenging Tesla on the battery front.

There are other companies in this industry. Nikola is developing battery-powered semi-trucks. And there are companies working on charging and battery components. Examples of those include Blink Charging and Plug Power.

There are also companies that manufacture the technology for the cars. Intel and Nvidia will also have a role in this emerging industry.

You can also look for investments in companies who focus on lithium. Batteries are a major component.

Mutual Funds or Exchange Traded Funds

The other way to invest in this industry is to use an exchange-traded fund or a mutual fund. The financial industry has been very innovative over the years. When industries like this emerge, they create a fund to focus on these companies. You can buy the fund instead of trying to pick individual stocks.

The Difference Between Using Stocks and Funds

The big difference between the two is the potential risk and reward.  Both ways of investing offer the opportunity to benefit from the growth of the industry. Both also experience a lot of volatility.

An individual company offers the potential for more reward, if you choose a good one. But when you pick the wrong one, you could lose more.

Using a fund reduces the potential gains. When you buy funds, you make smaller bets on a larger list of companies. Not all of them will be the big winner. You own shares of Tesla, GM, and Ford. You also may own shares of Nvidia and Intel.

The Lesson From Amazon

Amazon went public in May of 1997 in the middle of the dot-com boom. Since its offering, it has been one of the best-performing stocks over the last quarter-century. But early on, there was a lot of volatility.

In its first five years of existence, Amazon suffered significant price drops.

  • It fell more than 20% twice.
  • There were two 40% price drops.
  • One price drop exceeded 60%
  • And one time the price declined 90%!

Withstanding that much volatility takes a strong stomach and nerves of steel. Emerging technologies are not for the faint of heart.

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If you would like to consider an investment in electric vehicles, talk to a financial planner. They can help you understand how it fits within your plans and your goals.

 


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About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors.    He specializes in helping hard working, middle class families plan for retirement.

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Short Squeeze? What the Heck Is That?

Short Squeeze? What the Heck is That?

What the heck is a “short squeeze”? With the recent activity in GameStop, clients have been asking about this.

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Buy Low-Sell High

To understand this, we have to start with the most basic premise of investing, buy low, sell high.” When investing, most people buy the investment first and hope it appreciates in value. Then you can sell it for a profit.

Short sellers have the same objective, but they do transactions in reverse. They sell at a high price with the hope of buying the stock at a lower price in the future. In a short sale, you normally don’t sell a stock you already own. Instead, you borrow the shares from somebody and sell them. 

Margin Loans

In the investment industry, these are margin loans. A margin loan requires capital up front to start the transaction. In some cases, that might be 50%. If you’re going to sell $10,000 worth of stock short, you have to have $5,000 cash in the account.

There is also a maintenance requirement. This is the amount of capital you must keep based on what happens with the share price of the stock that you sold. For some firms, the maintenance requirement is 30%.

Here is what happens if the stock price goes up suddenly like GameStop did. Our $100 stock goes to $200. Now you owe $20,000. Your maintenance requirement is 30%, but you only have $5,000 in the account—or 25%. This triggers a margin call, which means you must meet the maintenance requirement.

Why Borrow?

Borrowing creates leverage which can enhance your returns. It can also enhance your losses. Here is an example. You short sell 100 shares of a stock trading at $100 for $10,000. The stock price falls to $80 and you buy the shares.  You made $2,000 on this transaction.  Because you used leverage, your rate of return on this transaction is 40% ($2,000 profit divided by $5,000 capital).

What Happens When You Receive a Margin Call? The Short Squeeze

The short sellers can add cash to their trading accounts. But many companies do not have extra cash to add to their accounts. Many individuals will not have a lot of extra cash either. This forces short sellers to either buy the stock at a higher price or sell other positions to cover the margin call. This is the short squeeze.

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About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors.    He specializes in helping hard working, middle class families plan for retirement.

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Why Not Use Dividend Stocks For Retirement Income?

Why Not Use Dividend Stocks for Retirement Income?

Today we answer a viewer question about using dividend stocks to create retirement income.

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Our question from Ronald. He writes:

I am looking to retire soon and trying to determine the best way to generate retirement income with interest rates so low. Traditionally, you could have done this with treasuries or CDs. Why wouldn’t buying dividend stocks paying 4% to 5% makes sense? In addition to the dividends, you have the opportunity for appreciation.

The Challenge of Low Interest Rates

Ron makes a couple of good points. Interest rates are ridiculously low right now. Traditional methods of using bonds or CD’s to generate income are a challenge. Ten-year Treasuries are yielding about 1%. Thirty-year Treasuries yield about 1.8%. CDs, unless you lock those up for a few years, are going to be well below 1%. Using these interest-bearing investments to create retirement income is very difficult.

Using Dividend Stocks For Retirement Income

Why can’t you use a portfolio of dividend-paying stocks to create that income? You can, and there are some benefits. The dividend income is more than you would earn on a lot of fixed-income investments. You also have the opportunity for capital appreciation. Many of these companies will increase their dividends over time. And there are some tax advantages.

The Challenges

1. Volatility

But there are significant challenges to doing this. The first one is volatility. Companies who pay good dividends will decrease in value. You are going to see periods where your account drops 20%-30%. You must be able to withstand those periods, and not sell something at an inopportune time.

2. Portfolio Construction

The next challenge you have is how you build your portfolio. You want to make sure you have diversification across different industries. You want to make sure you are picking good companies.

Oil companies provide a great example of why you should diversify. When oil prices went down last year, many oil companies saw their share prices decrease. Many of them also decreased their dividend. Investing too much in one industry could impact your ability to maintain your income.

Stock selection is also important. Look for companies that have good earnings as well as a decent payout ratio. (The payout ratio is how much of the earnings are being paid out as dividends.) If a company is paying more in dividends than they earn, it could be a problem down the road.

You also want to look at their dividend history. Has the company been able to maintain their dividend over time? Have they been able to increase their dividend over time? Or have they had periods where they cut the dividend? When you depend on that income, the last thing you want to see is your income cut.

You want to be cautious of owning too few companies. When you own too many shares of one company, bad news could hurt your account.

3. What if You Need Extra Income?

You may find you need extra income. This can also be a challenge. You can sell positions that have appreciated in value. But when you sell those shares, your future dividend income is going to decrease. It can create a problem if you do need extra income. One of the ways to address that challenge is to have a bigger emergency fund on hand. When you need extra income, use your emergency fund and not disrupt your regular income flow.

Tax Advantages for Using Dividend Stocks to Create Retirement Income

This can be a tax-advantaged way to generate income in a non-IRA account. Qualified dividends receive preferential tax treatment. For most people, qualified dividends get taxed at 15%. It could be lower, depending on your total income. Other types of income are taxed at higher rates.

Qualified dividends come from common stocks of US companies and some international companies. When you build a portfolio of common stocks, you are going to be in a more tax-advantaged position.

Some higher-yielding investments pay dividends that are not qualified. Real Estate Investment Trusts (REIT’s), Master Limited Partnerships, and Business Development Companies pay good dividends. But those payments are not qualified. You can hold those, but you will not see the same tax benefits.

If you can handle all the challenges, using dividend stocks to create retirement income can be a good strategy. But it may not be easy.

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About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors.    He specializes in helping hard working, middle class families plan for retirement.

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Investing vs. Speculating

Investing vs. Speculating

Today we are going to talk about the difference between investing and speculating.  

We have all heard about GameStop and some of the other companies. There were meteoric rises, significant drops, and prices went right back up. There is a lot of speculating and manipulation going on with this company. At the end of the week, it caused some extra volatility in the stock market.

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We want to cover a couple of different things today. First, let’s talk about the difference between investing and speculating.

Investing vs. Speculating

Investing is a long-term process that we use to build wealth over time.

Speculating is a short term bet to pursue a big payoff.

Investing —if you avoid key mistakes, and ride through some of the setbacks—has a high probability of success over long periods of time.

Speculating has a high probability of failure. But a big return potential.

Investing is a boring, uneventful process—most of the time. There are periods of absolute terror, like last spring.

Speculating is an adrenaline-pumping game. It is exciting and exhilarating.

Most of us want to be investors and pursue the long-term accumulation of wealth. It is fine to speculate from time to time. But understand you could lose everything you bet very quickly.

If you make big bets trying to time your entry points in and out of something like GameStop, you have a low chance of doing it well. You may have some temporary success, but at some point, things are going to go against you. Things can get very ugly before you have a chance to react.

If you want to be a speculator, go for it. Keep your bets small and only bet what you can afford to lose.

Anxiety in the Stock Market

These events are causing some temporary anxiety for the stock market. But there are big differences in what’s going on with these few companies and what most people try to do. The trading activity in companies like GameStop does not decrease the value of the other great businesses.

We’ve seen many temporary setbacks over the past 100 years. This may be another one.  For investors who own shares of good companies, stick with it, and don’t panic, things tend to work in their favor.

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About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors.    He specializes in helping hard working, middle class families plan for retirement.

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A Stock Market Crash is Always Coming

A Stock Market Crash is Always Coming

A stock market crash is always coming.  

A good friend of mine sent me an article last week written by the folks at motleyfool.com. Four Reasons the Market will Crash in the Next Three Months.

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The reasons they gave were:

  • Increased restrictions due to the virus
  • The vaccine euphoria would evaporate. (Remember in the last quarter of 2020, the stock market got a big boost on the vaccine news.)
  • Democrats would win the two Senate races in the Georgia runoffs. (This already happened.)
  • And history repeating itself.

Here’s the truth about the stock market.  The stock market goes up, it goes down, and then it goes back up, again. There is always a crash of some magnitude coming.

Crashes are Normal

Your definition of a crash and my definition of a crash are probably two different things. To me, a crash is a significant drop. What we saw last spring, that was a crash. Others include:

  • The “dot com” bust
  • the Great Recession
  • 1987
  • And the end of 2018, when the market dropped almost 20% over the course of three months.

You can look at the data going back into the 1920s and see that market crashes happen all the time.

Annual Corrections

The average calendar year correction since 1980 is -14%. The smallest was -3%. And the small corrections are rarer than the bigger ones.

The largest was -47%. That happened back in 2008. Last year, the correction was -35%. It was the second-worst drop in the last 41 years.

These events happen regularly. What is more important is what happens after the crashes. The stock market’s total return in 2020. was +18.4% last year. It erased the losses and produced a gain of almost 20%!

A stock market crash is always coming

Over the last 41 years,

  • There has been a drop of -10% or more at least 23 times
  • the market has gone down by more than -14% 16 times
  • and the compounded average annual return over the 41-year timeframe is +11.9% per year.

Stop and think about what has happened over the last four decades.

Despite all that happened, the stock market rewarded investors with an 11.9% average annual return.

Don’t worry about the headlines. You can write these stories every month from here to eternity. The crashes are going to happen. History shows us time and time again, those who weather the storms are rewarded.

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About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors.    He specializes in helping hard working, middle class families plan for retirement.

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Is Bitcoin a Good Investment?

Is Bitcoin a Good Investment?

Is Bitcoin a good investment? It is the new frontier in the investment world.  Its gains over the past six years will catch your eye.  Today we will answer a listener question about the digital currency and its characteristics.

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Is bitcoin a good investment

Our question is from Chris. He writes, “A guy at work keeps talking about Bitcoin. I don’t understand it. What is it and should I consider investing in it?”

Bitcoin, along with a few others, is a digital currency. It is not backed by a country or a central bank. An encrypted public ledger verifies the ownership of the coins. This ledger uses blockchain technology and it is very difficult to change. There are people who use computers to verify the transactions using digital cryptographic keys.

Bitcoin and Gold

In many ways, Bitcoin is similar to an investment in gold.

  • You can buy in various currencies, just like gold.
  • Its price fluctuates with changes in demand, just like gold.
  • And it is used as a store of value, just like gold.

But it is also different. Most businesses do not accept gold as a form of payment. You can use Bitcoin and other digital currencies to buy and sell goods and services. You can use it on PayPal. Some online retailers will also accept it for payment.

Growing Popularity

Bitcoin has become very popular to investors for a couple of reasons. The first is its meteoric gains over the last several years. It started trading in mid-September 2014. The price then was about $460. Last week, it closed at over $18,800. The average annual return of the Bitcoin has been about 82% per year.

The other appealing aspect of Bitcoin is that it is not a government-controlled currency.

Caution: Proceed with Care

There are many concerns when investing in Bitcoin.

Volatility

Bitcoin began trading in September 2014. Since then, we have seen

  • one price drop of more than 80%
  • another price drop of nearly 60%
  • three more drops of more than 30%
  • and three more drops of at least 20%.

This equates to eight bear markets in six years. It can be a very wild ride—more so than stocks and gold!

Taxes

There are tax consequences to sell your coins. Those sales get taxed as capital gains and losses. You need to be aware of your holding periods to know whether it’s short term or long term.

Are Purchases Considered Redemptions?

If you are using your Bitcoins to buy something, is that considered a redemption? This is a vague area. In some cases, using your digital currency as payment is considered a redemption. This could create a taxable event you did not expect.

Fees

There are some transaction fees to buy and sell Bitcoin. You want to be aware of those.

Non-traditional Businesses

You cannot buy cryptocurrency through most traditional financial institutions. Major brokerage firms and banks won’t hold or execute the trades.

The “Wild West” of Finance

Many governments fear criminals use Bitcoin to launder money. The United States asks if you have a cryptocurrency account on your tax return. They ask to help them track potential criminal activity.

Security of your account is also a concern. It’s a new frontier with very little regulation. There are many concerns about the security of your digital key and avoiding hackers.

Your digital key is very important. Recently, a CEO from a cryptocurrency exchange died with his passwords. He had over $150 million tied up in cryptocurrency. His family cannot access those accounts without the digital keys.

How do You Buy It? (My Own Experience)

The first thing you need to have is a digital wallet. There are many well-known providers. I used Coinbase. I opened an account in less than 10 minutes. I had a little difficulty linking it to one of the banks I deal with, but I was able to fix the issue.

Coinbase charges a minimum transaction fee of $2.99. The costs are then about 1.5% of the amount you buy or sell.

Overall, the process was very easy.

If you want to use a brokerage firm, try Betterment or Robinhood.

Is Bitcoin a Good Investment?

It has been terrific if (and that is a big “IF“) you can withstand the volatility. But nobody knows how it will do in the future. Right now, it is near its all-time high. You could be buying high, hoping it goes higher. You may want to wait for a correction—it tends to correct frequently. And there are tax consequences when you sell your coins.

You need to be careful and make sure you have your strong passwords written down somewhere. If something happens to you, your loved ones can access that account. 

Blockchain

Blockchain technology has a lot of potential uses in many different industries.

  • you could use it to verify your title to real estate
  • governments could use it for online voting security
  • Stock exchanges can use it to verify ownership of stock certificates. This could speed up trade settlements
  • companies like FedEx and UPS can use it to verify their deliveries
  • the Certified Financial Planner Board of Standards is already using blockchain to authenticate credentials

Bitcoin is a new frontier in the investing world. If you would like to learn more or get an objective opinion about how cryptocurrency could fit into your plan, check with a financial planner.

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About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors.    He specializes in helping hard working, middle class families plan for retirement.

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