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Bear market: What it is and how to invest during one

What is a bear market?
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A bear market is a prolonged period of price declines in a stock or entire market, usually of 20 percent or more from a recent high. Investors typically track the world’s major indexes like the S&P 500 and the Dow Jones Industrial Average to see when they enter bear market territory.

Individual stocks or asset classes can also enter a bear market if they experience price declines of 20 percent or more. The good news is that bear markets do not tend to last long. According to the Schwab Center for Financial Research, the average bear market lasts only around 15 months.

What is a bear market?

There is no exact science for distinguishing or recognizing a bear market, but market watchers generally refer to a decline of 20 percent or more as a bear market.

Bear markets often occur in the period before an economic downturn, and they largely indicate that investors are starting to pull back. If there is a higher ratio of risk-averse investors to risk-tolerant, this can also often be considered a bear market, or “bear-market territory.”

Conversely, in a bull market, investors charge ahead and often buy at a rapid pace. When investors start to hear that markets could be headed for a bear market or into bear market territory, it’s important to take notice and be ready to adjust your investments, if needed.

Bear markets often signal recessions but can sometimes occur in the midst of longer-term bull markets, representing a temporary lull. Since it’s difficult to discern which way markets will swing and when, keeping an eye on your investments is all the more important.

Bear markets could be caused by an overheating of the economy via runaway inflation, political unrest that bleeds into markets, overextended consumers or some other cause entirely.

How bad are bear markets?

Although investors fear bear markets, they are fortunately short-lived in many cases.

As mentioned above, the average bear market lasts about 15 months. Meanwhile, the shortest bear market in history lasted just one month, occurring in 2020 at the outset of the COVID pandemic.

On average, stocks lose around 36 percent during a bear market, says Hartford Funds citing data from Ned Davis Research. To put that into perspective, the average bull market sees a 114 percent gain. According to Hartford Funds, investors who are anticipating a 50-year investing horizon can expect to live through about 14 bear markets. That means becoming comfortable with market dips and learning to ride a bear market out.

Bear markets can cause investors to become skittish, which can result in investors selling assets from fear rather than from bear market forces alone. . This can become contagious, and only further deepen a bear market. Investors who might not have had the intention of selling before can all of a sudden get trapped in a contagious selling frenzy, which can lead to selling assets that could be more valuable in the long term.

How to invest in a bear market

Although bear markets can be concerning, they also provide opportunities to investors. If you know where to look, you can find opportunities to make attractive investments or at the very least, maintain the ones you already have.

Below are some strategies to help get you through a bear market and keep your investment goals intact.

Fight the urge to sell it all off

The most brash strategy would be to sell everything and move all positions into cash. This safeguards your money but may not be the best move to protect it long term. In low-inflation or low-interest rate environments, it might not make that much of a difference.

Considering bear markets tend not to last too long, the money lost sitting in cash with high inflation could potentially be worse. The mood surrounding a bear market can be bleak, but it’s important to fight the urge to sell everything off at the first sign of a headwind.

Invest defensively

Another option is to invest in defensive stocks or funds that traditionally perform well during market downturns. These may be in areas that are considered necessities, regardless of the market situation. It includes food and personal care stocks. Utilities are another sector that tends to perform well during market downturns.

A prudent investor would look to shift some of their portfolio towards these assets during an anticipated downturn, especially in high-rate or high-inflation environments, as it could prove more beneficial than cash.

Hedge with bonds

Investing in bonds is also a common strategy to protect oneself during a bear market. Bond prices tend to move inversely to stock prices, and if stocks decline, a bond investor could stand to benefit.

Short-term bonds in a bear market could help investors weather the (hopefully) short-term downturn. Higher-quality or investment-grade bonds would be a better choice here for investors whose goal is to hedge overall market risk during bear markets. Choosing riskier bonds during a bear market could compound losses from equities that might already be underperforming during a bear market.

Hedge with dividend stocks

Dividend stocks pay out a portion of a company’s profit back to the investor in the form of a dividend, so even if the stock price falls, investors can still receive income. Dividend stocks are a smart way to hedge the effects of a bear market, as income coming in counteracts the losses in other assets.

Dividend stocks also tend to be somewhat less volatile than the average stock, giving your portfolio some extra protection that way, too.

Take advantage of the lipstick effect

The “lipstick effect” is a theory that consumers tend to spend more on tiny indulgences during economic recessions and downturns rather than spend their money on luxuries. While this could fall under “personal care” categories as recommended above, cosmetic companies in particular tend to fare well during economic downturns and many attribute this to the lipstick effect.

To double down, investors could consider cosmetic companies that also pay dividends to boost their portfolio during a bear market. Major players in the beauty industry can provide stability as well as dividends during times of market uncertainty. The idea is that even during times of economic downturn, consumers can still afford small luxuries. One can achieve this through cosmetics, but also through small luxuries like Starbucks or a night out to eat. Investors can take advantage of this by leaning into similar stocks or funds that follow popular food and entertainment industries.

Re-balance your portfolio

Bear markets are a good time to re-assess any growth stocks or small-to-mid-cap stocks you have held on to. Market instability might prove to be too much for still-developing businesses to handle, and without the financial resources of their larger counterparts, certain growth stocks might be better left to the side.

This is not to say that you should sell off all of your assets right away – bear markets can also provide a wonderful buying opportunity for the right growth stocks – but a reassessment would be wise. Moving into higher percentages of bonds and stable asset classes is an obvious move, and keeping an eye on value vs. growth stocks will be key in the long term. Growth stocks can have their place in a diversified portfolio, but value stocks that are fundamentally sound and have the potential for long-term success will be particularly important during market downturns.

Stay the course

The most important thing an investor can do during a bear market (once they’ve assessed their holdings accordingly) is to wait it out. It’s not easy watching headlines blare all day and listening to friends speak about selling everything off, as it only adds to your jitters. Investing is a game best played long, and what you do during the downturns will define your performance over time.

Most investors in retirement accounts like 401(k)s and IRAs will do well to stay put in their investments. Unless you have an immediate need for cash, you will likely regret selling everything off once the market recovers.

Bottom line

Bear markets can be painful, but thankfully are usually short-lived. While it may seem like selling during a bear market would be easy to do, timing the market can be impossible, even for professionals. This means the most important thing an investor can do is pick high-quality investments with the intention to hold them long-term – while always keeping a keen eye on positions that might need special attention like growth stocks and potentially volatile investments.

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.

Written by
Georgina Tzanetos
Investing reporter
Bankrate reporter Georgina Tzanetos covers investing and retirement.
Edited by
Senior investing and wealth management reporter