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Surviving a Bear Market

Not that long ago, the idea of a bear market seemed almost inconceivable. For an entire generation of investors, the great bull runs of the 1980s and 1990s were the only markets ever experienced. But the new millennium brought with it a dose of reality, and even novice investors have learned that markets can — and do — go down as well as up.

Weathering a down market can be frustrating — especially if you’re using the same investing strategies that worked well when the market was on its way up. In fact, surviving a bear market requires patience, a long-term perspective, and the use of different strategies to help minimize the impact of falling stock prices on your portfolio.

Putting Market Returns in Perspective
Bear markets are nothing new. Since 1950, the S&P 500 has undergone nine bear markets. The average bear market has lasted about 35 months, and the market has fallen by an average of 31.7%. In contrast, the nine bull markets during this time period lasted more than four years on average, with an average gain of 136.2%.1

The most recent market downturn follows the longest economic expansion in our nation’s history; between 1991 and 2000, U.S. output as measured by Gross Domestic Product increased by an annual average of 7.3%.2 During this same period, stock markets clocked in exceptional performance, with the S&P 500, a benchmark for U.S. stocks, gaining more than 18% annually.1

But such growth is the exception, not the norm. Over the past 50 years, the S&P 500 has recorded a more modest 11.0% average annual return. And if the boom years of the late 1990s are excluded from this figure, the S&P 500 average advance was only 9.2%.1 Accordingly, if you are to survive a bear market, the first thing you need to do is readjust your sights from the unsustainable performance levels achieved in the late 1990s.

Should You Sell?
Not surprisingly, the first reaction to a falling market is to bail out. But that kind of short-term thinking may not be in your best interest — especially if you sell at a loss. Before selling, you should consider several factors. First, look at your time horizon; i.e., when will you need to use the invested funds. If you are investing for the long term — for retirement, for instance — then there’s a strong likelihood that the market will rebound before you need to use the funds. Second, consider your alternatives. If you take your money out of equities, where will you invest it? Remember that in the long term, stocks have outperformed the other asset classes — bonds and money market securities — by a significant margin, although past performance is no guarantee of future returns.

Surviving Bear Markets Chart

Maintain a Portfolio That’s Right for You
If you haven’t already done so, take a good look at your investments as a whole. What is your portfolio’s asset allocation — your mix of stocks, bonds, and cash equivalents? If you use your risk tolerance — your emotional and practical ability to handle risk — to guide the asset allocation process, you’ll be better prepared to cope with market volatility.

Reviewing your asset allocation can help you answer another question about your portfolio: Is it adequately diversified? In other words, have you spread your money among different investments to potentially help reduce risk? Different securities do better at different times. Therefore, holding a variety of investments creates the potential for those that perform well to compensate for those that do not over a period of time. Neither asset allocation nor diversification guarantee against investment loss.

Consider the performance of the U.S. stock and bond markets in 2000, for example: Although large-cap stocks, as measured by the S&P 500, lost 9.11%, long-term government bonds gained 16.36%.3 Investors who invested in stocks and bonds may not have experienced the same declines in their portfolio value as investors who invested only in stocks.

Finally, when assembling or maintaining a portfolio, consider tapping the expertise of a seasoned financial professional who has been through a number of market cycles. He or she can make suggestions regarding your portfolio mix, explain current market trends, and help you stay focused on your long-term financial goals.

 

Four Tips for Surviving Bear Markets

  • Implement a well-thought-out investment plan and then stick with it. You may increase your chances of being around when the bull takes its next run.
  • Do not make investment decisions based on short-term market drops or gains. Instead, evaluate how an investment fits into your overall financial strategy.
  • Look at a bear market as a buying opportunity. Some stocks may be undervalued following a broad market decline, allowing you to invest more in high-quality companies.
  • Talk with a financial professional. He or she may have been through volatile periods before.

1Source: Standard & Poor’s. Based on the daily price close of the S&P 500. A bear market is defined as the S&P closing at least 20% below its previous high. Its duration is the period from the previous high to the lowest close reached after it has fallen 20% or more. A bull market is measured from the lowest close reached after the market has fallen 20% or more to the next high.

2Source: U.S. Department of Commerce. Based on the change in nominal Gross Domestic Product.

3Source: Standard & Poor’s. The S&P 500 is an unmanaged index considered representative of large-cap U.S. stocks. Long-term bonds are represented by long-term (10+ years) Treasuries. Individuals cannot invest directly in any index. Past performance is no guarantee of future results.

Points to Remember

  1. Market drops should be viewed in a long-term historical perspective rather than in a short-term context.
  2. Historically, bear markets have been followed by bull runs whose magnitude and durations have been greater, although past performance is no guarantee of future returns.
  3. Before selling, you should consider your time horizon, your investment goals, and your investment alternatives.
  4. In the long term, stocks have outperformed the other asset classes — bonds and money market securities — by a significant margin, although past performance is no guarantee of future returns.
  5. Consider adjusting your asset allocation in light of falling equity values to make sure it is adequately diversified and in keeping with your risk tolerance and long-term goals.

 

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