How to Adjust Your Investing Strategy When the Bear Is About to Strike

If it's the last week of the month, then it's time for David Gardner to give his listeners what they want -- literally -- by answering their questions.

In this segment of Rule Breaker Investing mailbag episode, he fields one of the more common -- and fundamental -- queries that arise if you're advocating a long-term, buy-and-hold strategy: What should investors do differently if they "know" that a big market downturn is coming soon? Given the increasingly prevalent view that we are overdue for a major "correction" -- and what makes falling stock prices more "correct" than rising ones, anyway? -- the answer is of immediate concern to many followers of the Fool.

A full transcript follows the video.

This video was recorded on April 25, 2018.

David Gardner: Mailbag Item No. 1: This one comes from Tim Menore writing in. "Hi, David. Great show. I love listening to it every week. My question is in regards to The Fool philosophy of buying and holding for many years. I agree with it, for the most part, but as someone who reads a lot of investing articles, the general consensus among the 'experts' seems to be that while we are OK now, within the next couple of years the bull market will end [as they always do at some point], and we will suffer a large crash.

It could be because of various socioeconomic factors, but most say it would be at the point where the Fed raises interest rates too high and the yield curve inverts. My question is if you see all these things happening, would you still just keep holding? Wouldn't it be smarter to cash out and wait for the next market to fall before buying back in at much lower prices? This has been perplexing me, so I thought I would ask. Thank you for reading this and thank you for all that you do. Tim Menore."

Well, thanks Tim! And I'm going to do my best to address your question fairly directly, but in an indirect manner because I spoke to this a few months ago in San Francisco, California. I grabbed the transcript of that, and I'm going to just present some of those thoughts right now.

This feels like a really relevant question I think a lot of people were asking, especially when we were in San Francisco a couple of months ago. It was that week when the market dropped. I think my portfolio lost about 8% in a single week. You may remember headlines like "Dow Drops 1,000 Points," and there was at least one morning where a lot of people were waking up, maybe a little early, to see whether the market would keep on so-called crashing. You might remember that. That was the week that we were in San Francisco, and that was the opportunity that I had to say what I'm about to share with you.

And what I'm about to share I will morph slightly so it sounds like it's for this podcast as opposed to for that audience, but you'll understand that there's a little bit of crossover between those things, and here's my best shot at answering your question about where the market's headed and volatility.

I started by saying it's natural to want to say a few things about the market volatility. I didn't want it to be a theme for the day for that Motley Fool ONE San Francisco audience. I mean, I wasn't letting it preoccupy me and I hope you're not getting preoccupied by this question, as well, Tim, but I do feel a need to speak to that, so I guess I want to say three things.

The first is market volatility. Yes -- yes -- it happens. And yes, it has been volatile. My wife, who is not nearly as interested in the stock market as I am, said to me recently, "You know, isn't it the machine? The machines. They're coming in and they're doing all this trading, and it's creating these crazy, whipsaw motions."

And I said, "You mean, the same machines that were in operation last year?" And last year, as you know, was one of the least volatile years in market history. In fact, programmed trading has been happening for a few decades, so the machines have always been there through volatile and not-so-volatile times.

So, I don't think it's the machines, per se. We've lived through a time of remarkable calm, 2017. My brother's been wont to point out it's natural for the market to drop and so, yes, point No. 1, Tim and everybody, is yes, it has been. It has been more volatile, here, in 2018.

You know, perhaps my most retweeted tweet of the year, so far, is one of my watchwords, and it's "the market always goes down faster than it goes up, but it always goes up more than it goes down." And you have to keep both of those thoughts [somewhat opposed thoughts] in mind to succeed over the only term that counts as investors -- by definition -- the long term.

The reason investing is great is because the stock market always goes up more than it goes down and one of the simplest, best proofs of this is just to step back and look at a graph of the Dow Jones Industrial Average or the S&P 500 over the last hundred years. It's the classic lower-left to upper-right graph which every consultant wants to show you. It's the truth, and it's for logical reasons that will continue to recur, as will volatility.

That was point No. 1 -- volatility, yes.

Point No. 2. It's so short term, a lot of the market reporting that we get. I mean, it's comic. It's bizarre. I like to use sports analogies so imagine if I told you ahead of this coming baseball season [that has now started, the first few weeks, and we're going to aim this at the San Francisco Giants since this was for a San Francisco audience].

Imagine if I told you before the season that the San Francisco Giants would win 100 games and lose 62. There are 162 games in a baseball season, so 100 wins, 62 losses. That's a great season. They might well win the division. If they do that they might win the World Series.

Now, imagine if I told you ahead of time that you can decide to trade in or out of the Giants and their wins and losses at any point during the season. But I'm telling you at the end of those 162 games that they will win two-thirds of the time. Remember that their actual performance from one game to the next is going to be completely randomized -- the W's and the L's occurring in randomized order.

Now, imagine if you decided to trade within that atmosphere. The conclusions that you draw about whether this is a good way to spend your time. The likely results that you would generate. Probably, not very good.

Imagine if I also told you that during the season if you wanted to make those bets for and against the Giants at any point, every time you jump in or jump out, you're going to have to add a transaction fee component, as well. A fee, as well, for doing that. It just doesn't make much sense.

And it makes even less sense when the Giants have a particularly bad day. Imagine if that were a national story. When the Dow Jones drops 1,000 points, that's the big headline for the newspapers that day, even though 1,000 points isn't much in percentage terms, anymore. Imagine if that happened in baseball. Imagine if the Giants lost a game 14 to 2 and the one headline they got the whole season was, "Giants Lose 14 to 2. We're going to have a special CNBC hour tonight to discuss that game."

Meanwhile, largely going unreported are all of the wins, or any context that talks about the season, or how they're doing in the standings; any sense of history about how the Giants have done or other teams that have, say, started with 50 wins and 30 losses. [What] they've gone on to do. Imagine if there were no context at all.

So, the biggest message I think a lot of us get outside this podcast [those of us who follow the financial media] is wow, what a crazy week that was. What a crazy time. The Dow Jones dropped 1,000 points. That's the big headline.

And over the years, Tom and I used to do a lot of media around those kinds of events, and I've just largely stopped doing it because it seems they always want The Motley Fool to trot us out to calm the fears in these times, and it ends up contributing to that in some ways. To make our big appearance every time the market drops; it doesn't make a lot of sense.

You know, the beauty of the market, and what we've been doing together on this podcast, and if you're a Motley Fool member, is that we're finding remarkable companies, often earlier ahead of the mainstream, and no one is wanting to interview us when we pick those stocks in our services.

And then when those stocks hit major milestones [which fortunately a few of them do if they go up 20x in value, or 50x, or 100x], there's no one calling us from NPR or CNBC saying, "Hey, we'd love to have you on to talk about a 100-bagger. A 100x gain in that stock."

And, yet, what really matters? That's why we're here -- both the past reasons that have brought us here and our future expectations as investors and listeners of this podcast -- is it's a bizarre and ridiculous media world that surrounds the stock market and becomes fodder for major, lurid headlines. The few times the Giants lose 14 to 2 en route to [well, if you're a Giants fan, anyway, and I know you're hoping for it] a championship season.

Even our language is wrong. "Correction." And I do rant about this on my podcast. I've done that in the past, so I'm sure you've heard this before. I'm not going to go into a full rant, here, because we need to get to our next mailbag item, but it's always correct [is it?] when the market drops. That's a correction?

I think the most correct thing about the stock market is that it averages about a 10% annual return. That's -- that's -- correct. The notion that, well, anytime it drops that's a correction and now it's even to the point, these days, where there's an official designation of that now codified term. We need it to be exactly at a 10% drop, and then we officially, now, will call that a "correction."

So to me, it's gotten even sillier from when I think 20 or so years ago I started first ranting about this term that we use, correction, which shows a wrongheadedness that I guess we're all repeating back and forth to each other, and tabulating carefully to see if we get a correction, which I guess, as of that week a couple of months ago, we officially did have a correction.

And then the last thing I'll say, Tim, and then, darn it, let's get to the next item [but you can see I care about this stuff]. The last thing I'll say is third, what I'm going to call "volatility navel-gazing," because it can cause us to lose focus on what's most powerful for investors, and that's the persistent and unrelenting force of technological change in the future. Looking backwards now until today, think about your best stocks and my best stocks. A lot of them have benefited because we saw ahead of time the technological change that was coming.

And I think most of all for younger people listening to this podcast, or if you're a parent thinking about your children, or a grandparent thinking about your grandkids, the future matters most of all for younger people. I mean, they're going to be living through more of it than we will; so, the more that we're thinking about the future and focusing them, there, with their dollars, and our dollars, and our thinking the better off we'll all be.

As I've often said, make your portfolio reflect your best vision for our future. Always be thinking ahead. Be optimistic. Think about the world that you want to create, because sure enough your dollars and mine, our capital, is helping shape the world. Every purchase decision you make -- every investment decision you make, nudged up -- was received by somebody who took that money in and prospered because you decided to buy their product or invest with them. Truly we are shaping the world every day with our financial decisions, and the future matters so very deeply.

Tim, I hope those were some helpful thoughts for you as you think about whether there might be a crash a few years from now or not, or a few months; and yeah, as you probably would expect, for anybody who I would say is under the age of 65, I think it's smart to ride out those so-called corrections.

And even when there are crashes [and we've had a few of those in the last few decades], think about it. Take it all in all. We've prospered so greatly over the 25 years of The Motley Fool's history. The 25 years of these markets. We've prospered because we've shown some of the very characteristics that we're constantly talking about here in Rule Breaker Investing. Things like patience. Things like foresight. Thinking about the future. Thinking about who's going to disrupt whom and where we can put our money as we create a better world together. I hope that's helpful.