Bear Market Survival Guide

Millions of investors have never experienced anything like the painful stock

market slump we’ve seen over the past year. A record-shattering bull market

that had endured more than nine years peaked in March 2000.

In the following 12 months, the U.S. stock market fell more than 28%, as

measured by the Wilshire 5000 Total Market Index. Some $4.2 trillion in

market value evaporated in less than a year. And the decline was not confined

to the United States—foreign stock markets also fell sharply. ® In the midst of the first bear market in a decade, it’s not surprising that many

investors are worried and wondering what to do. This Plain Talk bulletin

aims to put the market downturn in perspective and offers six common-sense,

time-tested guidelines to help investors cope with market volatility. plain talk Six bear market survival tips

In 1924, cowboy humorist Will Rogers offered a simple rule for successful investing: “Take all your savings and buy some good stock, and hold it ’til it goes up, then sell it. If it don’t go up, don’t buy it.”

Of course, Rogers was joking. Unfortunately, many people think that they can find a method to buy stocks just before they go up, and sell them just before prices fall. But after decades of watching, we have yet to see a timing strategy that has consistently outperformed a buy-and-hold strategy. Even if timing strategies were found to work “on paper,” the real-world costs of trading and taxes would almost surely doom them to subpar results.

But if “avoid downturns” isn’t the answer, what should investors do? These six basic guidelines can help you continue toward your long-term investment goals, come bear or bull market.

1Don’t act impulsively. guidance on carrying it out, it’s likely that you are “the leading expert” when it comes to your own It’s natural—even for experienced investors—to finances and temperament. become nervous when account balances are falling along with the financial markets. The urge to change your investment mix can be powerful, especially 3Keep your balance. when a downturn gets worse and news gets grimmer. How badly has the bear market mauled your But impulse and emotion are enemies, and it pays to portfolio? That probably depends on the extent resist them. This is true not only in bear markets but to which you had diversified your holdings. also in bull markets, when euphoria can tempt you to “double up” on your holdings that are performing Fooled by the unusual length of time that large-cap best. For example, during the latter stages of the growth and technology stocks had led the market, 1990s bull market, many investors switched from some pundits were saying that the “new economy” lagging market sectors (bonds and value stocks) into had made diversification an obsolete idea. But then soaring technology stocks. The switch proved very technology stocks abruptly changed from leader to costly as technology stocks plunged. laggard—an event that has occurred across all sectors many times in the past, as shown below. Follow your plan, not the herd. 2 Past Performance Is No Guarantee—Really! Savvy investors understand that returns from stocks Rank Among Market Sectors Based on Total Returns and bonds constantly fluctuate and that these ups Economic Sector ‘85–’87 ‘88–’90 ‘91–’93 ‘94–’96 ‘97–’99 ‘00–’01* and downs will sometimes be extreme and lengthy. Consumer Staples 1 2 8 6 6 6 The key is not to avoid downturns (see tip #1) but Basic Materials 2 10 6 7 11 8 rather to prepare for them by selecting a mix of Health Care 3 1 10 2 4 4 stocks, bonds, and cash investments that makes sense Communication Svcs. 4 3 7 8 2 10 for your situation. Your plan should be based on such Utilities 5 5 9 10 10 1 Consumer Cyclicals 6 8 2 11 3 9 basic but unique variables as your investment time Capital Goods 7 6 5 4 5 7 horizon, your objective, the security of your income, Energy 8 4 11 5 8 2 the extent of your resources, and your tolerance for Financial Services 9 9 1 3 7 3 market fluctuations. And while you may want to Technology 10 11 4 1 1 11 seek an expert second opinion on your plan or some Transportation 11 7 3 9 9 5 *Through March 31, 2001 Sources: The Vanguard Group, Wilshire Associates Inc. 2 Perhaps the single biggest lesson from the 2000–2001 downturn is that diversification—the 4Continue your investment program. simple concept of not putting all your eggs in one Most investors build wealth systematically through basket—is still an investment virtue. That means regular investments, perhaps by payroll deductions for diversifying across asset classes—stocks, bonds, and a retirement plan at work or through an automatic cash—but also within asset classes. Include both investment program. This systematic approach— growth and value stocks, as well as large-, mid-, and known as dollar-cost averaging—can help you to put small-capitalization companies in your portfolio. the market’s fluctuations to work for you by lowering the average price you pay for fund shares. And it can Diversify to Manage Risk be a disciplined way to keep emotion from altering 60% Stocks/ Broad Stock Growth 40% Bonds Market Stocks your plan. Clearly, dollar-cost averaging cannot 0% –5 guarantee you a profit on your investment or protect –11.2% –10 you against losses when stock or bond prices are –15 falling. And dollar-cost averaging is unlikely to work –20 –24.8% for you if you are unwilling or unable to continue –25 investing during a long downturn in the markets. Total Return Total –30 –35 After all, to earn the stock market’s 15.0% annual –40 –42.5% average return over the past 20 years, an investor had –45 to stay invested in stocks through two earlier bear markets—including the October 1987 crash and the This chart compares the total returns from March 31, 2000, through March 31, 2001, of three hypothetical asset mixes: (1) 60% Wilshire 5000 Total Market Index (the 20% decline from July to October 1990, a period entire U.S. stock market)/40% Lehman Brothers Aggregate Bond Index (representing spanning Iraq’s invasion of Kuwait. the total market of U.S. bonds with maturities over one year); (2) 100% Wilshire 5000 Index; and (3) 100% Russell 3000 Growth Index (the growth stocks among the 3,000 largest U.S. stocks). By ensuring that your portfolio is balanced and broadly diversified, you won’t escape damage during a bear market, but you may avoid a catastrophic A way to make up lost ground decline. Note that past returns are not an indication of future returns. If you think the bear market is endangering your chance to meet your investment goals, you may want to boost your savings. No one can Moreover, by investing in mutual funds rather than change the past or future returns from the financial markets, but you individual securities, most investors have been better may be able to increase how much you’re investing. able to manage risk through diversification. Research by Morningstar, a mutual fund tracking company, shows that nearly one in every three U.S. stocks lost 20% or more of its value in 1999. Yet fewer than one 5Make any portfolio changes gradually. in every 400 U.S. mutual funds lost that much over If the bear market has convinced you that your the same time period. tolerance for the volatility of stocks is less than you once thought, or if you’re simply frightened, No bear for bonds you may want to “sell down to the sleeping point.” But Vanguard suggests that you act in a measured Despite the bear market for stocks, bonds have been in a bull market. In way. Change your long-term investment portfolio the 12 months ended March 31, 2001, the bond market returned 12.5%, gradually, and resist the urge to make drastic as measured by the Lehman Brothers Aggregate Bond Index. Bond prices changes. This reduces the chance that emotions move in the opposite direction from interest rates, so as interest rates are overriding a sound plan. Consider a limit of no declined amid a slowing economy, bond prices rose. more than 15% in changes to your allocations. For Money market investments also have provided solid returns amid the stock example, if your asset mix had been 70% stocks/ market slide: The Salomon Smith Barney 3-Month Treasury Bill Index earned 30% bonds, you might gradually move toward a 6.0% during the 12 months ended March 31, 2001. mix of 55% stocks/45% bonds.

3 Cheaper may not be cheap Online help for bear Hundreds of individual stocks—and the market as a whole—are much cheaper market survivors now than a year ago. However, that doesn’t necessarily mean they’re bargains. Before the downturn, stock prices had risen to unprecedented heights compared with such fundamentals as earnings, dividends, and book Has the recent real-world “stress test” given value. Despite steep declines, price/earnings ratios and other valuation measures for the overall market are still above long-term norms. you the sinking feeling that your risk tolerance

isn’t as high as you thought? Find out if your 6Tune out noise. investment program matches your needs by Ever felt dazed by the volume of facts, opinions, and statistics about the markets and investing? You’re not alone. Unprecedented amounts of information— taking Vanguard’s Investor Questionnaire at in print, via broadcast and cable, and over the Internet—flow to investors, including minute-by- www.vanguard.com/?planning. minute accounts of every day’s doings in the financial markets. Unfortunately, the overwhelming focus is on short-term events and forecasts, which amount, in the Simply answer a few questions about your end, to little more than noise. More information available in more ways can be a good thing. But the investment objectives and experience, time risk is giving in to the natural itch to react to all the information—to do something with it. Successful horizon, risk tolerance, and personal situation; investors are able to tune out the noise and keep their focus on their long-term investment goals and plans. This isn’t easy, especially when markets are soaring or the questionnaire will help you reassess your slumping, and the Internet enables you to check your account balances by the hour. But changing course asset allocation—and even give you fund with each new piece of information or commentary is unlikely to get you to your destination. suggestions. Or speak with one of our skilled

Make a plan; stick to it associates at 1-800-662-7447. As the past few years have shown, financial markets are fickle and unpredictable. But your investing strategy should be reasoned and www.vanguard.com steadfast. Once you’ve built a plan that makes sense for your situation and rests on the reasonable assumption that markets will go through periodic ups and downs, you’re in a position to stick with it, come what may.

4 The bear in perspective The 2000–2001 decline was the worst since 1987, when broad market indexes fell 33% from August to early December. Just what is a bear market? However, the bulk of that drop occurred on one day: the record A bear market is Wall Street jargon for a sharp decline in prices. There’s –22% crash on October 19, 1987. Though severe, the 1987 no official definition, but a bear market for stocks generally is defined as a downturn was brief—about three months from start to finish. decline of 20% or more in broad market indexes over at least a two-month By contrast, the bear market that began in March 2000 has period. (A bull market refers to a prolonged period of rising prices.) stretched for 12 months so far. Although it has been punctuated by a number of strong interim rallies, the downtrend has been Despite the market’s slump, the economy has not yet fallen persistent. into a recession—when economic output and employment fall. The Federal Reserve Board has been aggressively lowering One striking aspect of the 2000–2001 downturn is the interest rates in an effort to ward off a recession. Statistical uneven nature of the damage. The worst carnage occurred data available through March 2001 point more to a sluggish in technology, the best performing sector in 1999 and early economy than to a shrinking one. 2000. The Nasdaq Composite Index, which is dominated by large tech stocks, gained 87.4% in 1999 en route to an all-time Longer-term returns still solid high of 5049 in March 2000. But all those gains and more Despite the past year’s losses, longer-term results from the were lost as the index fell 64% from that peak to 1830 one stock market have been quite good by historical standards. year later. As bad as the 2000–2001 decline has been, those who’ve Yet while dozens of formerly high-flying stocks from the tech been in the stock market for five years or more probably have sector have been savaged by losses of 75% to 90%, a number achieved sizable gains, thanks to the extraordinarily bountiful of stocks that had lagged far behind in 1999 and early 2000 years preceding the downturn. have enjoyed solid gains since then. As the adjacent table shows, the average annual total return No “new era” of the Wilshire 5000 Index for the past 5 to 20 years has been well above the 11% average annual return from stocks In part, the uneven impact of the bear market reflects the over the past 75 years. extremes of valuations for stocks in early 2000, when talk of a “new era” for stocks was rampant. Many large technology Returns From the U.S. Stock Market* stocks were selling for more than 100 times earnings from the Periods Ended March 31, 2001 previous year, and many new Internet-related companies had 1 Year –19.1% huge market values even though the companies were posting 3 Years 3.8 big losses. At the time, skeptics’ warnings that the stocks 5 Years 14.2 were wildly overvalued fell largely on deaf ears; in retrospect, it’s clear they were right. 10 Years 14.8 15 Years 14.2 But the stock market downturn also reflected a general 20 Years 15.0 slowing in the economy during 2000. This slowdown made it plain that corporate earnings could not grow at anything like *As measured by the Wilshire 5000 Total Market Index. the rapid rates needed to justify the high prices for many large tech stocks. Indeed, in short order many companies were warning that their earnings would decline. As the market euphoria ended, many dot-com stocks were doomed—their operations were unprofitable, and investors declined to keep pumping cash into them.

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