What is a Bear Market?
Generally speaking, a Bear Market is when the stock prices decline due to a widespread pessimism among investors. In terms of quantifying the definition of a bear market, the most common and accepted is when:
- there is a downturn of 20 percent or more from a peak in multiple broad market indexes;
- it occurs in a short period of time (less than 1 year).
According to Investopedia, between 1900 and 2018, there were 32 bear markets, averaging one every 3.5 years. The last one was the “2008 global financial crisis” occurring between October 2007 and March 2009.
Also, the average length of a bear market is 367 days.
2008 Bear Market
What conclusions did the average investor extract from this 2008 bear market:
- SPY collapsed nearly 47%;
- A balanced portfolio of stocks and bonds (SPY-60% and AGG-40%), when compared with the SPY, only decreased 24%. That’s half of the negative return;
- Volatility associated with SPY during this period was 38%;
- If you had a balanced portfolio, the volatility was cut in half: 19%.
- Also, the maximum drawdown associated with the SPY was 55.20%.
From the last bear market, one very important point to learn is the importance of diversification. Adding bonds creates an excellent protection against a bear market plus strongly decreasing the volatility of the portfolio. Less volatility, less pressure to sell at the worst possible time.
What should we do when in a Bear Market?
For investors that have a portfolio of ETF, a bear market is usually an excellent time to buy stocks (or bonds). If you have a fixed allocation between stocks and bonds, you’ll have an excellent buying opportunity. Just rebalance your portfolio and keep it simple.
If I want extra safety, the time to build an emergency fund isn’t when you’re in a bear market. It’s before. When everything looks fine. So let’s do the math:
- If I have stability in my job/retirement income;
- Considering that the average length of a bear market is 367 days (basically one year);
- Have my house already paid;
- Insurance/government welfare to secure medical care should I need;
- Low expenses (and easy to control);
The average emergency fund (to cushion an eventual bear market) should have at least one year of expenses. Therefore an average investor doesn’t have to pull out investing money from the portfolio at the worst possible time.
Of course according to an average investor (and his tolerance to risk), one could increase even more the emergency fund.
An Emergency Fund, invested in cash or cash-type investments would give you a peace of mind that is very precious when everything is falling.
This post is only for information and education purposes. It’s not financial advice or any kind of advice. Make your own due diligence, you are the only responsible for your actions and decisions.