What is a ‘Bear Market,’ and What Do I Do?

As any investor has noticed, we are currently entrenched in a bear market.  

The technical definition of a bear market is a 20% drop from an all-time high in a stock index.  On average, bear markets happen every 5-6 years, meaning that the average investor will experience nearly 15 bear markets during his or her investing lifetime.  Bear markets vary in length, and can occur for any number of reasons.  Our current bear market seems to be driven (in large part) due to fears brought about by the high rate of inflation and the rapidly increasing interest rates.  It’s important to remember that the market is a forward-looking mechanism, which means that the market (up to this point) has anticipated a slowdown in earnings due to our current economic climate.  Markets tend to change direction when future expectations change.  Bear markets can be very short-lived or last for a couple years – only time will tell how long our current bear market lasts.

Each time a bear market occurs, it can produce a myriad of emotions for investors.  Some investors get excited about a bear market, viewing it as an opportunity to be more aggressive and generate a large return when the market turns around.  Other investors become very anxious, and have a tendency to decrease risk and pull back.  We also get a myriad of prognosticators giving us conflicting advice.  So, in the spirit of being strong stewards of our resources, how should we invest in a bear market?

1. Review your allocation and determine if it’s still aligned with your long-term goals.  It can be very tempting in the midst of a bear market to drastically alter allocation – it’s especially tempting to take chips off the table.  History proves, however, that this can be very unwise.  By remembering to take an eternal view with our resources (and not a short-term view), it can help us to look past the emotions created by a bear market.
2. If you can afford to be more aggressive, it may be a wise decision. As a general rule of thumb, it’s wise to have at least five years of planned distributions in low-volatility holdings.  These can consist of cash, money market funds, or conservative holdings within your investment portfolio.  If a bear market occurs, we want to be taking distributions from our more conservative holdings.  It’s often the case that households will have more than five years of distributions in low-volatility holdings.  If this is the case, it may be prudent to shift to a more aggressive allocation, even if it’s only 5-10% more aggressive.  The thinking is this – you’re able to purchase equities while the market is down 20%, and assuming the market recovers to its previous level, you’re able to participate in the upswing more fully.  If and when the market returns to its previous all-time high, that can be the trigger to reverse the trade and go back to the original allocation.  The key is not “guessing” or “timing” the market, but rather using specific data points.
3. If you’re in a contribution phase, consider increasing your savings rate. Investors making contributions to their investment accounts should view a down market as a gift.  Each time a contribution goes in, stocks are being purchased on discount.  In other words, an investor contributing during a bear market is able to acquire more shares for the same amount of contribution.  It’s a best practice to increase long-term savings rate by 1% annually until reaching the appropriate savings rate, and increasing during a bear market can make a drastic difference over time.

Please remember to review these strategies with your financial professional prior to implementation, and please keep in mind that past market performance is not indicative of future performance.

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