On May 20, 2022, the S&P 500 entered the bear market territory. As the popular adage goes, everyone’s a genius in a bull market: when the market’s rising and economic prospects are rosy, it can almost seem too easy to get a decent return. However, many investors, especially less-seasoned ones, can be unsure of how to navigate a bear market in a way that doesn’t undo the gains of a bull market.
With the right kind of knowledge, guidance, and resolve, investors can not only make it through a bear market relatively unscathed, but can even come out much better on the other side. Let’s learn more about bear markets and how you as an investor should tackle them.
What is a bear market?
A market is typically considered to have turned into a bear market once it has dipped 20% from a recent high, usually over the course of at least a few weeks. (So flash crashes due to unexpected news will not typically qualify as bear market triggers.) Bear markets are simply an unavoidable part of life, and do not necessarily indicate anything pathological: it is effectively impossible for a market as a whole (as represented by market indices such as the S&P 500 or the Dow Jones Industrial Average) or individual stocks to rise indefinitely, without going through major corrections.
It might be heartening to know that on average, bear markets result in a dip of 36%, while bull markets take stocks up by 114%. Moreover, on average, bear markets are much shorter-lived than bull markets: 9.6 months vs 2.7 years.
What causes bear markets?
A bear market usually arises in the wake of news and events that leave investors pessimistic with respect to the performance of specific companies or sectors, or of the market as a whole. There are several important economic signals that institutional investors as well as experienced retail investors keep an eye on to gauge the health of the markets. These include:
- The pace of hiring
- Inflation
- Interest rates
- Consumer confidence
- Geopolitical events
- Legal cases with major ramifications
- Wage growth
- Companies’ SEC filings
While any number of these factors could come together to trigger a bear market, the effects tend to multiply as more investors start reacting to the market movements. Spooked investors will often liquidate their existing positions in order to cut their losses or avoid future losses, and so that they can park their money in safer, fixed-income securities such as government bonds. In effect, many investors deal with a bear market by withdrawing from it and waiting for the market to show signs of bouncing back.
Some of the factors responsible for the ongoing bear market are the Ukraine-Russia conflict, China’s economic slowdown, inflation – likely precipitated by the gargantuan sums of money ‘printed’ during the COVID-19 pandemic, and the rising interest rates brought in by the Federal Reserve in an attempt to control inflation.
Why bear markets can be good for investors
While bear markets can be intimidating for relatively new investors, more seasoned investors know that there are several ways to minimize the impact of a bear market on one’s portfolio. In fact, bear markets can even turn out to be a blessing in disguise, as they often hold forth the opportunity to buy stocks at a discount compared to the prices their fundamentals would suggest.
Here are some time-tested techniques that will help you optimize your returns in a bearish environment:
- Make sure to diversify
It’s almost impossible to predict how specific stocks or markets will perform over the long term, which is why going all-in on a particular stock or asset class can be risky.
It is much more prudent to diversify the stocks you hold and the asset classes that you have invested in. For instance, if you’re mainly invested in tech stocks, consider picking up some stocks in the consumer staples or banking sectors as well so as to minimize the risk of the entire tech sector underperforming.
Similarly, if you’ve only invested in stocks, consider picking up some bonds, gold, or REITs (real estate), so as to spread out your risk over a variety of asset classes that are either uncorrelated or only weakly correlated.
- Use dollar-cost averaging to your advantage
Dollar-cost averaging (DCA) is a technique where an investor invests a fixed amount of money in a given asset periodically, typically every month. DCA stands in contrast to investing a large lump sum into an asset in one go.
DCA enables investors to continue investing during uncertain times while reducing the impact of any further corrections. If you invest a lump sum in a stock, and the stock then dips further, you will be in the red until the stock returns to the point where you bought it. But if you use DCA, a dip will simply represent a chance to buy some more of that stock at a lower price, thus reducing the downside risk.
You can use a Systematic Investment Plan (SIP) to DCA into an asset. What’s even better is that such SIPs can be automated, thus taking the human element out of the picture, leading to higher discipline.
- Invest in recession-proof sectors
While no sector is necessarily fully immune to the effects of a major economic downturn, there are some that are more resilient than others. Among such sectors are the consumer staples and utilities sectors: no matter how bad things get, people still need soap, toothpaste, and energy.
Thus, it is a good idea to add stocks or ETFs from such sectors to your portfolio. While the upside might be modest, the downside is likely to be capped as well.
- Remember that investing is a long-term project
The stock market rewards patience and forbearance. The truly spectacular returns go to those who maintain their positions for many years, if not decades. As long as you have picked your holdings in a reasonable manner, you should maintain confidence in them through rough times, provided that their fundamentals haven’t dramatically changed.
About 40% of investors who pull out of markets solely due to fear often end up regretting it. Bear markets definitely test the fortitude of all investors, but you should remember that the prognosis is likely to look good eventually and that if you hold on, you will profit greatly once the bulls come back to the fore.
Nevertheless, if you’re worried you might end up selling when you shouldn’t, you can take things out of your hands by using an advisor – even better an automated one. Hence, now is a good time to visit www.appreciatewealth.com to learn more about our automated investing offerings.
Tame those bears
Once you’ve put this knowledge into practice and seen the results for yourself, you’ll agree that even the fiercest of bear markets can be navigated successfully. Diversify your portfolio. Use dollar-cost averaging. Invest in resilient sectors. And don’t panic-sell: remember that time in the market is better than timing the market. Use these strategies to maintain a healthy portfolio even in the face of sickly markets. Appreciate uses the power of AI to manage your investments so that your long term financial goals remain achievable even through such rough weather.
