What Is a Bear Market and How Should I Invest During One?

Bear markets, when assets plummet 20% from recent highs, are among the scariest market events you'll encounter. But don't stop investing.

Alana BensonOctober 6, 2020
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What Is a Bear Market and How Should I Invest During One?

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The words "bear market" strike fear into the hearts of many investors. But these deep market downturns are unavoidable, and often relatively short, especially compared with the duration of bull markets, when the market is rising in value. Bear markets can even provide good investment opportunities.

Here's more on what a bear market means, and steps you can take to make sure your portfolio survives (and even thrives) until the bear transforms into a bull.

Bear markets: When investment prices drop by 20% or more

A bear market is defined by a prolonged drop in investment prices — generally, when prices fall by 20% or more from their most recent high. There can be bear markets for a market as a whole, such as in the Dow Jones Industrial Average or the S&P 500, as well as for individual stocks.

While 20% is the threshold, bear markets often plummet much deeper than that over a sustained period, not all at once. Though the market has a few occasional “relief rallies,” the general trend is downward. Eventually, investors begin to find stocks attractively priced and start buying, officially ending the bear market.

Bear markets are characterized by investors’ pessimism and low confidence. During a bear market, investors often seem to ignore any good news and continue selling quickly, pushing prices even lower.

While investors might be bearish on an individual stock, that sentiment may not affect the market as a whole. But when the market turns bearish, almost all stocks within it begin to decline, even if individually they’re reporting good news and growing earnings.

What causes a bear market and how long do they last?

A bear market often occurs just before or after the economy moves into a recession.

Investors carefully watch key economic signals — hiring, wage growth, inflation and interest rates — to judge when the economy is slowing. In the case of the COVID-19 pandemic, some of the indicators were a little different. Things like widespread closures, spikes in unemployment claims and social distancing measures were a few of the clues that the economy was headed for trouble.

When they see a shrinking economy, investors expect corporate profits to decline in the near future. So they sell stocks, pushing the market lower. A bear market can signal more unemployment and tougher economic times ahead.

Bear markets tend to be shorter than bull markets — 363 days on average — versus 1,742 days for bull markets. They also tend to be less statistically severe, with average losses of 33% compared with bull market average gains of 159%, according to data compiled by Invesco.

The coronavirus bear market that began March 11, 2020, entered a bull-market phase just a couple of weeks later, though the full economic fallout from the virus is yet to be determined.

How to invest during a bear market

1. Make dollar-cost averaging your friend

Say the price of a stock in your portfolio slumps 25%, from $100 a share to $75 a share. If you have money to invest — and want to buy more of this stock — it can be tempting to try to buy when you think the stock’s price has cratered.

Problem is, you’ll likely be wrong. That stock may not have bottomed at $75 a share; rather, it could tumble 50% or more from its high. This is why trying to pick the bottom, or “time” the market, is a risky endeavor.

A more prudent approach is to regularly add money to the market with a strategy known as dollar-cost averaging. Dollar-cost averaging is when you continually invest money over time and in roughly equal amounts. This helps smooth out your purchase price over time, ensuring you don’t pour all your money into a stock at its high (while still taking advantage of market dips).

There’s no doubt that bear markets can be scary, but the stock market has proven it will bounce back eventually. If you shift your perspective, focusing on potential gains rather than potential losses, bear markets can be good opportunities to pick up stocks at lower prices.

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2. Diversify your holdings

Speaking of picking up stocks at lower prices, boosting your portfolio’s diversification — so it includes a mix of different assets — is another valuable strategy, bear market or not.

During bear markets, all the companies in a given stock index, such as the S&P 500, generally fall — but not necessarily by similar amounts. That’s why a well-diversified portfolio is key. If you’re invested in a mix of relative winners and losers, it helps to minimize your portfolio’s overall losses.

If only you could know the winners and losers in advance. Because bear markets typically precede or coincide with economic recessions, investors often favor assets, during these times, that deliver a steadier return — irrespective of what’s happening in the economy. This “defensive” strategy might mean adding the following assets to your portfolio:

  • Dividend-paying stocks. Even if stock prices aren’t going up, many investors still want to get paid in the form of dividends. That’s why companies that pay higher-than-average dividends will be appealing to investors during bear markets. (Interested in dividends? See our list of 25 high-dividend stocks.)

  • Bonds. Bonds also are an attractive investment during shaky periods in the stock market because their prices often move in the opposite direction of stock prices. Bonds are an essential component of any portfolio, but adding additional high-quality, short-term bonds to your portfolio may help ease the pain of a bear market.

3. Invest in sectors that perform well in recessions

If you want to add some stabilizing assets to your portfolio, look to the sectors that tend to perform well during market downturns. Things like consumer staples and utilities usually weather bear markets better than others.

You can invest in specific sectors through index funds or exchange-traded funds, which track a market benchmark. For example, investing in a consumer staples ETF will give you exposure to companies in that industry, which tends to be more stable during recessions. An index fund or ETF offers more diversification than investing in a single stock because each fund holds shares in many companies.

» Still curious? Learn more about what to invest in during a recession

4. Focus on the long-term

Bear markets test the resolve of all investors. While these periods are difficult to endure, history shows you probably won’t have to wait too long for the market to recover. And if you’re investing for a long-term goal — such as retirement —  the bear markets you’ll endure will be overshadowed  by bull markets. Money you need for short-term goals, generally those you hope to achieve in less than five years, should not be invested in the stock market.

Still, resisting the temptation to sell investments when markets plummet is difficult, but it’s one of the best things you can do for your portfolio. If you have trouble keeping your hands off your investments during a bear market, you can have a robo-advisor or a financial advisor manage your investments for you, in both the good times and the bad.

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Frequently asked questions about bear markets

How can I tell when a bear market is coming?

Bear markets look obvious in retrospect, but hindsight is always 20/20. It’s not easy to determine when stock prices have peaked and you’re entering a bear market or to predict if a relatively mild correction will turn into a full-blown bear.

Still, investors do have some rules of thumb. One of the best ways to determine whether a bear market is pending is to watch interest rates. If the Federal Reserve lowers interest rates in response to a slowing economy, it’s a good clue that a bear market could be on the way. But sometimes a bear market begins even before interest rates are lowered.

Warning signs that a bear market might be coming shouldn’t lead you to change your investment strategy. Long-term investors should not try to predict the market. Instead, ensure that your portfolio is funded with money you won’t need for the next five years, and is both well-diversified and aligned with your risk tolerance. Doing so means you’ll likely ride out the highs and lows of the market better than someone who is trying to time it.

What's the difference between a bear market and a market correction?

Bear markets are the bigger, more ferocious versions of market corrections, which are typically brief, shallow drops in stock prices of between 10% and 20%. Corrections are often relatively short. During the bull market from 2009-2020, the S&P 500 saw six corrections.

Corrections can become bear markets, but more often they don’t. Between 1974 and 2018, there were 22 market corrections, and only four turned into bear markets.

What’s the difference between a bear market and a bull market?

While a bear market is when stock prices drop by 20% or more, a bull market is when stock prices rise by 20% or more. During bull markets, investors tend to be optimistic and reward even modestly good news with higher stock prices, fueling an upward spiral.

Wondering about how quickly the market recovers? The following calculator shows how long it took the S&P 500 to recover from past market crashes — and what your portfolio would have grown to if you had stayed invested:

Former NerdWallet writer Jim Royal contributed to this article. 

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