Preparations for the coming bear market

What am I going to do when the bear market comes?

It is easy to get good returns when the market is going up. It is just carrying you up. 
But the a bear market will come. And then you will find yourself on the edge of the waterfall and the strong waters will carry you down very fast.
And no one knows when the turn will happen.


We are in an extended bull market right now. There might be a couple of genius people out there who know when this bull market ends. I don't know that and I don't know anyone who knows that. So I am on my own here.

In the last 70 years, there have been 13 bear markets. The average length of a bear market was 13 months. The average decline was about 25%.
Compared to the bull markets for the same 70 years there were 14 bull markets. The average length of a bull market was 46 months. The increase was on average 125.3%.

We judge our success by comparing to others and that leads either to "better" or "worse" evaluation.
But what if you compare your results only to that what matters?

What if I compare my results just to the one goal I had in mind when I started the 'Cash flow" challenge - to cover the yearly expenses. As long as I can achieve this, it is all fine.

Without knowing when the bear market comes, what remains for me is to prepare for the unknown.

What I have to work with:
I don't know when the market turns down.
I know for certain that it is going to happen.
I don't know how deep the drawdown will be. It could be as much as 50-60%.
I don't know how good the recovery will be.
I don't know if some of the stocks will ever recover (some stocks still didn't after 2018).


What I can do:

I can try to cover yearly expenses with the income from "Cash flow challenge". It is certain that all stocks will go down significantly. What will be left are just the dividends some of which may be reduced. I can try to cover the expenses with dividends but I think that will not be enough.  

Also I need to make sure that the other income sources will cover the time when the cash flow is insufficient. The other sources are jobs and emergency fund.

As long as I have the job, the yearly expenses are covered.
As long as my husband has a job, the yearly expenses are covered too.
Our emergency fund will cover at least 2 years of  absent income.

That way we have triple safety in case if the bear market will not produce the sufficient cash flow. That way the pressure is off.

The second step is to optimize the investments for the time of the bear market:

1. I need to go trough my holdings and see how they reacted to the last bear market and maybe eliminate those which didn't recover from the last one in 2009.
2. I will only use dividend paying stocks that in case of the bear market, there still will be some income from the dividends.
3. Bear markets are temporary and shorter than bull markets so the savings for retirement should not be severely affected. Even if the retirement savings will be affected, I am not planning to retire early or at least not before the next bear market is over. That should give the retirement funds enough time to recover.

What to do after you maxed out all tax advantaged opportunities?

After I maxed out all tax advantaged options, there is nothing else left for me then to open a taxable investments account.

What taxes would I pay on investments in a taxable account?

A taxable account is funded with post-tax money.
The interest, dividends and capital gains are taxed every year. 

1. Interest
It is taxed at ordinary income tax rate according to you tax bracket.


2. Capital gains and Qualified Dividends (2018)
Ordinary dividends and short term capital gains are taxed at ordinary income tax rate.

Qualified dividends  and long term capital gains are taxed at reduced rates: 

There is an additional 3.8% Net Investment Income Tax (or Medical Surcharge Tax) for capital gains, and dividends.
It applies to modified adjusted gross incomes exceeding $200,000 for singles and $250,000 married filing jointly.  



I am thinking of opening a separate "challenge" account in which I will try to learn how with certainty to achieve more than 1% yearly returns on my own. In this account I will not use indexing. 
Majority of my investments is in index funds at this time. Indexing is supposed to make more than 1% returns per year with relatively high certainty. 
The "challenge" account will be for trying it on my own. I will add a link to it here as soon as I start with that.