All of the major stock indexes have entered bear market territory for 2022. Inflation is at 40-year highs. As of October 20, 2022, the S&P 500 has lost more than 23% of its value since the start of the year. Economists predict a global recession is likely on the horizon.
It seems like every other day, investors are faced with a barrage of bad news. In such an environment, it can be difficult for investors to know what to do. Should you sell and get out while you still can? Should you invest more money to take advantage of low stock prices? Or should you simply stay the course without making any big changes to your investment strategy?
Below, we take a closer look at what a bear market is and how it differs from a recession. We also offer ideas and best practices that you can use to guide your investment strategy through this turbulent time.
What is a bear market?
While individual definitions may vary slightly, a bear market is generally understood to exist when securities prices fall by at least 20% from recent highs. This decline is usually paired with negative investor sentiment and, at its worst, outright pessimism.
While the term is most commonly applied to securities—namely, stocks and bonds—any market can be considered to be in a bear market if the above conditions are met. This includes commodities, precious metals, real estate, and even cryptocurrencies.
Bear markets can be broad in nature, affecting entire indexes (such as the S&P 500 or Nasdaq Composite Index), or they can be more narrow, affecting specific industries or even individual stocks.
It’s also important to note that, while a bear market is typically identified by a 20% decline in prices, prices can fall much further than that mark. According to Fidelity, in the average bear market, stocks actually lose 33% of their value.
Are we currently in a bear market?
Yes. According to most measures, we are currently experiencing a widespread bear market affecting all three major stock market indices:
S&P 500: The S&P 500 officially entered a bear market after declining 22.9% from December 31, 2021 through June 17, 2022.
Dow Jones Industrial Average: The Dow Jones Industrial Average officially entered a bear market after declining 20.95% from December 31, 2021 through September 30, 2022.
Nasdaq Composite Index: The Nasdaq Composite Index officially entered a bear market after declining 20.01% from November 19, 2021 through March 11, 2022.
Bear market conditions exist until new highs of at least 20% off of recent lows are reached. Despite volatility up and down year to date, all three of these indexes remain in a bear market as of October 19, 2022.
What is a recession?
Generally speaking, a recession is a period of economic decline or contraction. Recessions can occur on a national or global scale.
Identifying a recession is more of an art than it is a science. An important hallmark of all recessions is a drop in GDP during two successive quarters. But in and of itself, a reduction in GDP is not enough to diagnose a recession. Other signs that an economy has entered a recession include falling retail sales and rising levels of unemployment.
Therefore, it’s possible for a country to experience a two-quarter drop in GDP without actually entering a recession.
It’s also important to note that while bear markets and recessions sometimes coincide, that is not a given. It is possible to experience a bear market without a recession, and vice versa.
Are we currently in a recession?
There are a couple of ways to define a recession, so it’s tough to say whether we’re currently in a recession. One definition of a recession is two consecutive quarters of negative GDP growth. And by that definition, the United States is in a recession. According to the Bureau of Economic Analysis, the United States has experienced a drop in GDP in each of the last two quarters (-1.6% in the first quarter, and -0.6% in the second quarter).
And yet, most economists do not believe that we have entered a recession. That’s largely due to the fact that the country has not yet experienced a rise in unemployment or a significant reduction in consumer spending.
Considerations for Your Existing Investment Portfolio
During a bear market, it can be tempting to make dramatic adjustments to your investment strategy. While sometimes this can be warranted, in many cases there’s really no need to overhaul your portfolio. Below are some considerations to weigh before making any changes to how you invest during a bear market.
1. Revisit the reason you are investing.
Your investment goals are amongst the most important factors to consider before making any adjustments to your portfolio. That’s because your goals play a big role in determining your risk tolerance and investment horizon (discussed below). Without a clear understanding of your goals, it’s very difficult to build and maintain an efficient portfolio.
Of course, nobody’s goals are exactly the same. So sit down and ask yourself: Why are you investing? What do you hope to achieve by putting your money to work in the market?
A few common investment goals include:
Investing for retirement
Investing for your child’s future education
Investing to buy a home
Investing to start a business someday
2. Revisit your risk tolerance and investment timeline.
Risk tolerance is a measure of how much risk you are comfortable taking on in your investments. It should play a major role in determining the breakdown of your portfolio—what percentage of your portfolio you allocate to riskier assets, like stocks, and what percentage you allocate to less risky assets, like bonds.
Your investment timeline, on the other hand, is simply a measure of how long you have until you will need your money. Generally speaking, the more time you have until you need your money, the more risk you can take on (because you will have more time to make up for any potential losses).
3. Rebalance your portfolio as appropriate.
Using the three pieces of information above—your investment goals, risk tolerance, and investment horizon—you may come to the conclusion that yes, your portfolio does need to be adjusted. Rebalancing is simply the process of adjusting your portfolio allocation so that it is better in line with your risk tolerance, investment timeline, and financial goals.
Perhaps you’ve taken on more risk than you are actually comfortable with. In this case, it might make sense to position your portfolio more conservatively. On the other hand, maybe you’ve come to realize that your investment timeline is so far away that you’re happy to take on additional risk if it means greater potential gains. In that case, you might decide to position your portfolio more aggressively.
4. Consider investing excess cash.
Investing cash during a bear market (or really any time when prices are falling) can be a scary prospect. After all, there’s no telling just how far prices will fall. What if you get it wrong and end up losing money?
Investing in the stock market always comes with the risk of loss, but investing responsibly during a bear market can be a great way for smart investors to build long-term wealth. That’s because staying invested (and investing new money) during a downturn allows you to participate in the eventual market recovery—which have historically been very significant.
Consider investing excess cash you have during a bear market if you meet the following requirements:
Your emergency fund is well-stocked
You are not carrying any debt above 7% interest
Your risk tolerance and investment timeline warrant it
5. Consider harvesting tax losses in non-qualified accounts.
It’s never any fun to lose money on an investment. But there is at least one silver lining: Tax loss harvesting.
When you sell an investment asset at a loss, you’re allowed to write off those losses on your taxes (up to $3,000 a year). And if you have more than $3,000 in investment losses in a single year, the excess can roll forward into future years. The only catch? You’re not allowed to purchase the same assets for 30 days before and 30 days after you have harvested the loss.
Tax-loss harvesting is a term used to describe the process of selling a losing investment to realize tax benefits. Typically, proceeds of the sale are used to purchase assets similar (but not identical to) those that you sold, so that your overall portfolio allocation remains the same.
If you’ve experienced losses in your portfolio due to the recent market decline, tax loss harvesting can help you reclaim at least some of the lost value in the form of tax savings.
6. Consider buying Series I bonds.
Series I Bonds are a type of government savings bond that pay a guaranteed interest rate tied to the current rate of inflation. When inflation is high, I Bonds pay higher interest rates; when inflation is low, I Bonds pay lower interest rates.
This makes I Bonds an excellent choice for investors who are looking for a safe investment that is capable of matching today’s high rate of inflation. Series I Bonds protect your purchasing power by helping your cash keep up with inflation.
Learn more about Series I Bonds here.
Best Practices for Investing in a Bear Market
Dollar-cost average new dollars.
When it comes to investing new dollars, trying to time the market bottom is incredibly difficult to do consistently.
Instead of waiting for the “right” time to invest, consider dollar-cost averaging. Dollar-cost averaging means investing new money over time instead of all at once (for example, every week or every month) regardless of what the market is doing.
Not only does dollar-cost averaging help you turn investing into a habit, it can also lower the overall volatility of your portfolio, since it spreads your purchases out over time compared to lump sum investing.
Stay the course.
As long as your investment portfolio is well-diversified according to your risk tolerance, investment goals, and timeline, you may not need to make any changes whatsoever to your investment strategy. In this case, resist the urge to shake things up and simply stay the course. Every bear market in history has eventually ended and resulted in a bull market; this bear market is likely no different.
Limit the amount of market news you consume.
While you might think that staying on top of the market makes you a responsible investor, the truth is that consuming too much market news could be doing more harm than good—especially if it is giving you anxiety or causing you to dramatically reconsider your investment strategy.
Limiting the amount of market news that you consume during periods of turbulence like the one we are in today can make it much more likely that you will stick to your investment strategy.
Keep your emergency fund safe from the volatility of the market.
If you’re an aggressive investor, it can be tempting to throw every last dollar you have at your disposal into the market so that when the market eventually rebounds (as it is likely to do) you can maximize your gains. But this can be just as dangerous as pulling out of the market. Certain money should never be invested. Your emergency fund is one such example.
Why? Because you never know when you might experience a sudden and unexpected emergency or period of unemployment. When you invest your emergency fund, you risk having less cash when you need it most. In the worst case, you might be forced to sell your investments at a loss to tap those funds or may have very little left at all.
Generally speaking, an easily accessible high-yield savings account (some currently pay in excess of 2.25% APY) is a great spot for your Emergency Fund.
Focus on the Long Term
At the end of the day, nobody can control the markets. With that in mind, it’s important to focus on what you can control. That includes your budget and spending, your debt, and your overall investment strategy. In each of these, consistency is the name of the game.
So keep an eye on how you are spending your money, and reduce costs where you can. Build your Emergency Fund and pay down any high-interest debt you may have—especially if that includes variable rate loans or credit cards that could continue to go up in the coming months.
Frequently Asked Questions
1. Are we currently in a bear market?
Yes, all major US stock indexes have entered a bear market in 2022.
2. How many bear markets have we had?
Research conducted by investment consulting firm Yardeni Research posits that we’ve had 10 bear markets since 1950 (not including today’s environment). Going back to 1926, research conducted by Fidelity posits that we’ve had 17 total bear markets, or roughly once every six years.
3. How long do bear markets usually last?
Since 1950, the average bear market has lasted 388 days, or just over one year. But when you extend the time frame to 1926, the average bear market is shorter: 289 days, or about 9.5 months.
4. What are the key signals of a bear market?
A bear market is defined by a decline in the price of securities of at least 20% from recent highs.
That being said, many financial professionals use other signals as a guide to determine whether we are in (or approaching) a bear market. According to Bank of America, these include:
Rising interest rates
Tightening credit conditions
An inverted yield curve
A change in long-term growth expectations
Revisions to earnings estimates
5. Should you invest in a bear market?
Yes. Consider investing as long as your Emergency Fund is full, you don’t have any debt with an interest rate above 7%, you have an investment time horizon longer than three to five years, and you can handle the risk of loss that comes with investing.