Professional investors describe the market as a balance of two forces: fear and greed. When times are good, investors get tempted by greed. They buy investments to cash in on future profits and big gains. In bad times, fear takes over. Investors sell their assets and bail out of positions because they don’t want to lose money. Preparing for a bear market before it happens can change your portfolio’s long-term performance but what you invest in will depend on your situation. The best thing to do may be to work with a financial advisor who can provide you with advice that is unique to your financial plan.
What is a bear market?
A bear market is defined as any period in which prices fall by 20% or more. That’s what a bear market means, but it’s also important to understand what a bear market doesn’t mean. This isn’t a sign that the stock market will definitely suffer long-term losses, nor does it mean that a recession is necessarily coming. A bear market is a loss of value in stocks that take a significant amount of time to recoup when the downward trends end. A bear market typically makes many investors afraid of investing in the markets. A lot of people end up taking their money out of the market, losing any gains that had been erased by the current market condition. A bear market has always been followed by stronger gains in stocks that, eventually and as a whole, end up stronger than before the bear market began.
Tips for investing during a bear market
When a bear market occurs it typically takes between six and 18 months for stocks to recover their losses. In particular, if you need assets during that time period, for example, if you are retired or plan on buying a house, this can be a big problem. So what should you do? Here are four things you can do with your portfolio during a bear market:
1. Hold on if you can
Bear markets reflect what’s known as “systematic risk.” This means that stock prices often decline based on what’s going on in the market overall rather than the weakness of any individual business. Investors often sell because they don’t want to take losses in the market overall, not because they’ve lost confidence in any particular business.
This skews traditional price indicators. You can’t necessarily take losses as an indication that a given company has gotten weaker because falling stock prices may indicate that investors have lost confidence in the S&P 500, not the business mode except for when they haven’t.
So the first rule of thumb in a bear market is to avoid selling if you can. Or, at least, don’t make selling your first instinct. If you sell during a bear market you’re likely to absorb unnecessary losses from stocks that have declined despite the underlying company’s value.
That doesn’t mean you should have diamond hands. Just analyze risk the same way you always would. If you think that a company’s business model has gotten weaker, or that it never really had that value to begin with, then it may indeed be time to sell; a bear market can reveal overvalued assets. Just make your moves based on the fundamentals and avoid selling unless you’re sure it’s the right move.
2. Seek companies with high earnings per share
For the reasons above a bear market is an excellent time to buy stocks. Since investors are selling based on systematic risk, by definition they’ll often sell good companies for low prices. So this is a good era to hold stocks you already own and to buy stocks if you have the capital to do as long as they’re strong. But how can you tell the difference between a strong stock burdened with systematic risk and a weak company exposed by the market?
The truth is, there’s no sure-fire way to know. Anyone who says otherwise is lying. But a good rule of thumb is to look for what’s called “EPS,” or “earnings per share.” This is the measure of a company’s profits relative to its share price. A high EPS means that the company is making a lot of money relative to its share price, which often indicates a healthy company with an undervalued stock. These are often good buys in a weak market.
3. Invest in index funds
For many investors, the advice during a bear market doesn’t change. For example, invest in index funds. For most investors, most of the time, the best investment is an S&P 500 index fund. These tend to give you the best balance of diversity since an index fund represents a broad spectrum of individual stocks and assets vs. growth. This is more true than ever during a bear market.
While individual stocks may not recover from a bear market, historically the stock market overall tends to do so. As a result, buying into an index fund while the market is down is a good way to buy a historically strong asset at a reduced price. Now, this doesn’t guarantee any specific results or outcomes. However, on an ordinary basis, most investors should invest heavily in a good S&P 500 index fund most of the time.
4. Stagger your investments
Many investors look for bear markets as an opportunity to invest heavily. This practice is called buying the dip, and it can be a very strong approach to finance overall. It tracks Warren Buffet’s advice, after all, to “buy when others are selling and sell when others are buying.”Just be sure to practice moderation.
There’s no telling when a bear market has bottomed out, nor how long it will take for assets to recover their value. So you don’t want to go all-in at any given time. Instead, invest steadily over time. You can certainly buy more heavily during a bear market but do so in pieces. Invest a given amount of money one month, then another parcel the next. That way you can capture the gains of an undervalued market while not going too heavily in any given direction during a volatile and unpredictable era.
Above all else, be patient and remember that this too shall pass, often sooner than it seems.
The bottom line
Investing in a bear market typically creates fear for many investors, but it can actually just mean being more aggressive and patient in your investment decisions. More than anything else, it often means not changing your overall strategy much at all, although maybe getting a little more aggressive than usual. Working with a financial advisor can provide a huge peace of mind during a bear market because many have survived similar conditions in the market more than once.
Tips for investing in a bear market
The best way to manage your money in both good and bad times is through the help of professional advice that is unique to your situation. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
We’ve gotten started, now let’s dive into the details. Here are five strategies for investing in a bear market.