Investors seemingly toss around the term “bear market” whenever the stock market drops. But what does it mean? How long will it last? Most importantly, what should you do about it?
The term has a precise generation: a sustained period of declining stock prices where stocks have declined at least 20 percent from their previous highs.
If the S&P 500, for example, hit 5,000 and then declined by 20 percent to 4,000, that would be a bear market.
Bear markets aren’t unusual: since 1928, the S&P 500 has tallied 26 bear markets¹. Although many investors get nervous or fearful when the market is down by 20 percent, the reality is that market declines happen regularly. The market always seems to recover.
Fun fact: Although the origin of the term is unknown, experts believe down markets are called bear markets because bears swipe downward when catching their prey.
Why does a bear market matter?
Investors and even non-investors tend to get nervous when the stock market drops.
Consumer confidence erodes, because people are less confident in their ability to grow their wealth. They cut back on spending. If they’re in a position where they have to sell stocks, bonds, or mutual funds, they may lose money or make less than they’d hoped.
The leading study of market and investor performance, DALBAR, shows that investors who try to time the market do much worse than they would have if they’d stayed invested in the market. In fact, 25 of the stock market’s best days happened during bear markets.
The result is that overall economic activity decreases. In some cases, unemployment rises. It’s easy to see when a bear market happens. It’s not always as easy, but very important, to understand why.
What causes a bear market?
Typically bear markets are caused by an economic recession, a stock market bubble, or both.
Here’s what mainly drives those two factors.
- When economic conditions deteriorate, normally consumer confidence declines, leading to a decrease in spending and investment. This, in turn, leads to potentially falling stock prices.
- A stock market bubble occurs when the prices of assets, such as stocks, become inflated due to high demand and limited supply. When the bubble eventually bursts, prices drop sharply, often leading to a bear market. When economic conditions deteriorate, spending and investment typically decrease—resulting in weaker company profits—which, in turn, leads to falling stock prices.
It can be difficult for investors to make money when stock prices are falling, but there’s a silver lining: when stock prices fall, investors have the opportunity to buy those stocks at lower prices. That opportunity may not last long, though.
How long do bear markets typically last?
Although some bear markets can drag on for a year or more, in most cases the market recovers within a matter of months. The average time it takes for stocks to reach a new high following a bear market is 9-10 months.
Generally, bear markets last longer and are more severe when the underlying cause is an economic recession, and shorter when the trigger for a bear market is a simple market correction.
The good news for investors: bear markets are generally followed by bull markets, when the prices of stocks, bonds, or other assets continually rise. The 26 bear markets since 1928 have been followed by 27 bull markets¹. That cycle of bear and bull markets is important for investors to remember.
What should investors do during a bear market?
When the stock market is in decline, it can be difficult to know what to do with your investments. Should you sell everything and wait for the market to rebound? Or hang on and hope that the stock prices will eventually start climbing again?
Here are three tips for investing in a bear market:
- Check in on how you are feeling. It’s OK to feel a bit uneasy or even worried during a down market. While it’s generally a good idea to not look at your investments too often, it can be healthy to check in with yourself to gauge how you are feeling about your strategy. Bear markets offer a good chance to reassess your comfort level with risk. This doesn’t necessarily mean you should make changes to your investments, but, if you are uncertain about your overall strategy, you should consider talking to a professional to review your entire financial picture and see if your investments are aligned with your goals.
- Remain focused on what you can control. It can be easy to focus on what you can’t control because you are reminded of it every single day. News outlets are always talking about the economy, recessions, the markets, interest rates, and even inflation. Instead of focusing on these elements, try and focus on what you can control:
- How much you are contributing to your accounts.
- The types of accounts you are investing in (401k(k), IRA, Roth IRA).
- What you invest in and your level of diversification.
- The level of risk you are taking in your investments.
- Keeping your fees as low as possible.
- And your behavior. How you behave (i.e. remain disciplined) will often matter far more than how the market behaves.
- Look for opportunities. Bear markets provide some good opportunities if you know where to look:
- Continue to contribute to your accounts. While down markets can be unnerving, remember that you are buying shares of your various investments at lower prices. Dollar-cost averaging can be a great way to do this.
- Look for opportunities to rebalance your investments to keep your risk in check. Look to take losses when investments are down to offset gains and lower your taxes. And maybe consider a Roth IRA conversion while account values are down.
Final word
The smartest thing investors can do during a bear market is recognize that bear markets happen and they don’t last forever. The worst thing investors often do is try to time the market by selling stocks and pulling out when the market drops and then buying when the market rises.
Keep in mind that a bear market can be an opportunity to buy the stocks of good companies, mutual funds, or exchange-traded funds (ETFs) for less. When the bear market turns around, you’ll have assets you bought at a discount.
Above all, don’t panic. Bear markets are a fact of investing life, and a temporary one at that. Stay the course and in the long run the market will likely correct itself.
A CFP® Professional at Facet can help you manage every aspect of your financial life, including your investments, and help you make the financial decisions that are best for you.
