The words “bear market” strike fear into the hearts of most investors. But these deep market downturns are unavoidable, and often relatively short, especially compared with the duration of bull markets, when the market is rising in value. Bear markets can even provide good investment opportunities.
Here’s more on what a bear market means, and steps you can take to make sure your portfolio survives (and even thrives) until the bear transforms into a bull.
What is a ‘bear market’?
A bear market is defined by a prolonged drop in investment prices — generally, a bear market happens when a broad market index falls by 20% or more from its most recent high. There can be bear markets for a market as a whole, such as in the Dow Jones Industrial Average, as well as for individual stocks. Currently the S&P 500 is in the bear market territory.
While 20% is the threshold, bear markets often plummet much deeper than that over a sustained period, not all at once. Although the market has a few occasional “relief rallies,” the general trend is downward. Eventually, investors begin to find stocks attractively priced and start buying, officially ending the bear market.
Bear markets are characterized by investors’ pessimism and low confidence. During a bear market, investors often seem to ignore any good news and continue selling quickly, pushing prices even lower.
While investors might be bearish on an individual stock, that sentiment may not affect the market as a whole. But when the market turns bearish, almost all stocks within it begin to decline, even if individually they’re reporting good news and growing earnings.
What causes a bear market and how long do they usually last?
A bear market often occurs just before or after the economy moves into a recession, but not always.
Investors carefully watch key economic signals — hiring, wage growth, inflation and interest rates — to judge when the economy is slowing.
When they see a shrinking economy, investors expect corporate profits to decline in the near future. So they sell stocks, pushing the market lower. A bear market can signal more unemployment and tougher economic times ahead.
Bear markets tend to be shorter than bull markets — 363 days on average — versus 1,742 days for bull markets. They also tend to be less statistically severe, with average losses of 33% compared with bull market average gains of 159%, according to data compiled by Invesco.
The coronavirus bear market that began March 11, 2020 entered a bull-market phase just a couple of weeks later, though the full economic fallout is yet to be determined.
How to invest during a bear market?
1. Make dollar-cost averaging your friend
Say the price of a stock in your portfolio slumps 25%, from $100 a share to $75 a share. If you have money to invest — and want to buy more of this stock — it can be tempting to try to buy when you think the stock’s price has cratered.
Problem is, you’ll likely be wrong. That stock may not have bottomed at $75 a share; rather, it could tumble 50% or more from its high. This is why trying to pick the bottom, or “time” the market, is a risky endeavor.
A more prudent approach is to regularly add money to the market with a strategy known as dollar-cost averaging. Dollar-cost averaging is when you continually invest money over time and in roughly equal amounts. This helps smooth out your purchase price over time, ensuring you don’t pour all your money into a stock at its high (while still taking advantage of market dips).
There’s no doubt that bear markets can be scary, but the stock market has proven it will bounce back eventually. If you shift your perspective, focusing on potential gains rather than potential losses, bear markets can be good opportunities to pick up stocks at lower prices.
2. Diversify your holdings
Speaking of picking up stocks at lower prices, boosting your portfolio’s diversification — so it includes a mix of different assets — is another valuable strategy, bear market or not.
During bear markets, all the companies in a given stock index, such as the S&P 500, generally fall — but not necessarily by similar amounts. That’s why a well-diversified portfolio is key. If you’re invested in a mix of relative winners and losers, it helps to minimize your portfolio’s overall losses.
If only you could know the winners and losers in advance. Because bear markets typically precede or coincide with economic recessions, investors often favor assets, during these times, that deliver a steadier return — irrespective of what’s happening in the economy. This “defensive” strategy might mean adding assets to your portfolio such as Dividend-paying stocks.
3. Invest in sectors that perform well in recessions
If you want to add some stabilizing assets to your portfolio, look to the sectors that tend to perform well during market downturns. Things such as consumer staples and utilities usually weather bear markets better than others.
You can invest in specific sectors through index funds or exchange-traded funds, which track a market benchmark. For example, investing in a consumer staples ETF will give you exposure to companies in that industry, which tends to be more stable during recessions. An index fund or ETF offers more diversification than investing in a single stock because each fund holds shares in many companies.
4. Focus on the long-term
Bear markets test the resolve of all investors. While these periods are difficult to endure, history shows you probably won’t have to wait too long for the market to recover. And if you’re investing for a long-term goal — such as retirement — the bear markets you’ll endure will be overshadowed by bull markets. Money you need for short-term goals, generally those you hope to achieve in less than five years, should not be invested in the stock market.