Last week, we talked a lot about bear markets and dividends. This week, I want to close out our May series by talking about the silver linings of a bear market or any market downturn, for that matter. And we touched on this a bit last week, but, as I said then, the S&P 500 was in bear market territory, down about 25%, from January to October 2022, stabilizing slightly and ending the year down just a bit less than 20%. While this may seem like a terrible year for the stock market, there are hidden benefits to bear markets that are often overlooked.
For starters, bear markets provide opportunities to purchase stocks at a discount; think fire sale! When the market is down, stocks become undervalued, and investors can purchase them at lower prices. While this may not be too exciting in the short term as you watch the value of your portfolio dip, it can provide significant returns in the long term. This is a big deal because the more shares of a company you own, the higher the dividends (should they be dividend-paying) and the higher the appreciation when markets start climbing again. All good things!
Secondly, bear markets are an excellent opportunity to rebalance your portfolio. Certain stocks may become overvalued during a bull market, and others may be undervalued. However, during a bear market, most stocks decline in value, providing an opportunity to adjust your portfolio to take advantage of this. Rebalancing your portfolio during a bear market can help temper losses and position your portfolio for future gains when things swing in the upward direction.
Thirdly, bear markets can help to weed out weak companies from the market. During a bull market, weak companies may be propped up by the overall market growth. However, these companies may struggle to stay afloat during a bear market and may eventually be delisted. This can benefit investors in the long term, as it helps remove weak companies from the market and makes room for stronger and more stable companies to be listed, as I discussed in the second blog of the month.
So when in a bear or prolonged down market, here are some of my favorite strategies:
Dollar-Cost-Averaging: The most important thing to remember during an economic slowdown is that it's normal for the stock market to have negative years—it's part of the business cycle. If you are a long-term investor, one option is to take advantage of dollar-cost averaging (DCA). By purchasing shares regardless of price, you end up buying shares at a low price when the market is down. Over the long run, your cost will "average down," leaving you with a better overall entry price for your shares.
Playing Dead: There's an old saying that playing dead is the best thing to do during a bear market—it's the same protocol you’d follow if you met a real grizzly in the woods. Fighting back would be very dangerous. By staying calm and not making any sudden moves, you'll save yourself from becoming a bear's lunch. Playing dead in financial terms can mean doing nothing - don’t panic, don’t sell, just play dead and wait for the market to improve as it inevitably will, because if you get out when stocks are down, chances are quite good that you won’t get back in for the upswing. Why? Because, as I have said before, no one, not even me, has a crystal ball and can predict the exact day and time to get back in. And, because who wants to lock in losses, which is what happens when you take the “rats fleeing the ship” approach? I wouldn’t recommend it!
Diversification: I harp on this one a lot, and to be totally honest, despite using other words in these blogs - I’m simply restating the investment principles of faith, patience, and discipline and the investment practices of asset allocation, diversification, and rebalancing - BECAUSE they work. So, diversification - spreading your investments among stocks, bonds, and cash and across sectors and industries helps insulate you against market volatility in both the long- and short-term. This is the core principle of diversification however, how you slice things up is very personal. It depends on your time horizon, risk tolerance, goals, time until retirement, and much more. Armed with all that information, you can create an asset allocation strategy that may help you avoid some of the negative effects of a down market and having all your eggs in one basket!
With that, this month’s edu-blog series has ended, but I encourage you to keep these ideas in mind as we continue to face the bumpy ride together. And remember, a date and dollar-specific approach to all your financial goals is the way to ensure that you are always prepared and on top of the investment cycle.
Until next time…
One last thought, I believe an educated investor is an empowered investor. If you like what you’ve read and think your friends and family can benefit as well, please share.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested in directly.
All investing involves risk, including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Dollar-cost averaging involves continuous investment in securities regardless of fluctuation in the price levels of such securities. An investor should consider their ability to continue purchasing through fluctuating price levels. Such a plan does not assure a profit and does not protect against loss in declining markets.