The scariest market occurrences you’ll experience are bear markets, which occur when an asset’s value drops 20% from recent highs. However, long-term investors are able to persevere.
Many investors experience panic when they hear the term “bear market”. However, these severe market downturns are inevitable and frequently only last a short while, especially when contrasted to the length of bull markets, during which the market is appreciating in value. Even in bear markets, there are lucrative investing possibilities.
More information on what a bear market entails and precautions you can take to ensure your portfolio endures (and perhaps even flourishes) until the bear turns into a bull are provided below.
What is a Bear Market?
An extended decline in investment prices is what is known as a bear market; typically, a bear market is when a broad market index declines by 20% or more from its most recent high. A bull market, which is defined by gains of 20% or more, is the opposite of a bear market.
While 20% is the cutoff, bear markets frequently plunge much more than that over an extended period of time. A bear market may occasionally see “relief rallies,” but the overall tendency is negative. Pessimism and lack of confidence among investors are traits of bear markets. Investors frequently appear to disregard any positive news during a bear market and continue selling aggressively, driving prices farther lower.
Investors eventually start to discover attractively priced equities and start buying, effectively ending the bear market.
Bear markets are possible for both individual equities and markets as a whole, such as the Dow Jones Industrial Average. Investors’ negative sentiment about a certain stock is unlikely to have an impact on the market as a whole. However, practically all stocks inside a market or index start to decrease when it turns negative, even if they are all individually reporting positive news and increasing earnings.
How long do bear markets last, and what causes them?
Although it doesn’t always happen, a bear market frequently happens just before or after the economy enters a recession.
Investors closely monitor the hiring, wage growth, inflation, and interest rate indicators to determine when the economy is slowing.
Investors anticipate a short-term reduction in business profits when they observe a contracting economy. So, they sell equities, which causes the market to decline. A bear market may portend increased unemployment and difficult economic circumstances.
In general, bear markets last 363 days on average as opposed to 1,742 days for bull markets. According to data gathered by Invesco, they also tend to be statistically less severe, with average losses of 33% compared with bull market average gains of 159%.
1. Make dollar-cost averaging your friend
Let’s say a stock in your portfolio sees its price fall 25%, from $100 per share to $75 per share. It can be tempting to try to buy when you think the stock’s price has fallen if you have money to invest and want to purchase more of this stock.
Unfortunately, you’ll probably be in error. It’s possible that the stock hasn’t fallen 50% or more from its high; instead of bottoming out around $75 per share. Attempting to “time” the market or “pick the bottom” is perilous because of this.
A more conservative course of action is to consistently contribute funds to the market using a technique called dollar-cost averaging. You consistently invest money over time and in about equal amounts when you use dollar-cost averaging.
As a result, your purchase price is smoothed out over time, preventing you from investing all of your money in a company at its peak (but still profiting from market falls).
Bear markets can undoubtedly be frightening, but the stock market has shown over and again that they eventually end.
2. Diversify your holdings
Speaking of purchasing stocks at a discount, increasing your portfolio’s diversity to include a variety of assets is another wise move, down market or not.
During bear markets, all the companies in a specific stock index, like the S&P 500, often decline, but not always by the same percentages. A well-diversified portfolio is essential because of this. The overall losses of your portfolio are reduced if you have a mix of relative winners and losers in your portfolio.
If only you could predict who would win and lose. Investors frequently select assets that give a steadier return during these times since they typically occur before or concurrently with economic recessions. This is true regardless of the state of the economy.
The following investments could be included in your portfolio as part of this “defensive” strategy:
stocks that provide dividends. Many investors still desire dividend payments even when stock values aren’t rising. Investors will therefore be drawn to businesses that offer higher-than-average dividends during downturn markets. (Are dividends of interest? See our list of stocks with large dividends.)
Bonds. Because they frequently move in the opposite direction from stock prices, bonds are also a desirable investment during uncertain times in the stock market. Any portfolio must include bonds, but adding more short-term, high-quality bonds to your holdings may lessen the impact of a down market.
3. Invest in sectors that perform well in recessions
What investments are profitable during a bear market? Consider the products that consumers will always need because those industries typically do well when the market is weak. People still need petrol, groceries, and healthcare even in times of high inflation, therefore commodities like consumer staples and utilities typically fare better in bear markets than other commodities.
Through index funds or exchange-traded funds that follow a market benchmark, you can invest in particular industries. For instance, investing in a consumer staples ETF can expose you to businesses in that sector, which is more stable than others during recessions. Because each fund owns shares in numerous firms, investing in an index fund or ETF offers greater diversification than buying a single stock.
4. Focus on the long-term
All investors are put to the test during bear markets. Even while these times are difficult to endure, history indicates that the market will most likely rebound rather quickly. Additionally, the downturn markets you’ll experience if you’re investing for a long-term objective—like retirement—will be eclipsed by bull markets. You shouldn’t invest money you need for short-term goals, often those you intend to accomplish in fewer than five years, in the stock market.
Even yet, one of the finest things you can do for your portfolio is to resist the urge to sell investments when markets fall.
You can have a robo-advisor or a financial advisor manage your investments for you in both good and bad times if you struggle to keep your hands off them during a bear market.
Bear markets are, in the end, an excellent opportunity to review your goals and objectives and to remind yourself of the reasons you are invested where you are. Stay the course if your asset allocation feels appropriate. If something seems out of place, a down market might present a chance to reset your accounts while paying less capital gains tax than you would in a bull market.
Conclusion
When stock prices drop 20% or more from a recent high, it might be frightening, but investors shouldn’t panic.
The typical bear market lasts less than a year, and investors can lessen its effects by utilizing straightforward strategies like dollar-cost averaging, diversification, investing in areas that are more resilient to recessions, and putting a priority on the long term.
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