Bear markets are a part of investing in stocks.
We don’t know precisely when the next one is coming, but it is almost certain that it will happen.
A bear market is defined as a 20 percent or more drop in the market (as measured by the major indexes) for a sustained period.
Just to do the math for a quick example, if the Dow is trading around 13,500, it would take a drop of 2,700 points or more to fall into the bear range.
We are just now recovering from a rather brutal bear market that began with the dot.com meltdown in 2000 and accelerated during the wake of the tragedy of Sept. 11, 2001.
Most analysts note that the bear morphed into a bull market in October of 2002.
However, the market dropped some 47 percent during that short bear run.
It was not until the summer of 2007 that the market regained its position – and the Nasdaq has yet to recover its lofty dot.com highs.
When the market begins acting as if it wants to turn a bear (which may be a false signal), some investors panic, and convert stocks to cash after major declines.
This usually locks in losses because if the market turns around, the investor will have to buy back in at a higher price.
A better strategy is to have a well-balanced portfolio of stocks and bonds.
Often quoted research by Ibbotson Associates of Chicago shows the value of this strategy.
They looked at the worst five-year periods between 1926 and 2005 and measured the performance of four portfolios:
What does this tell us?
This research suggests a conservative portfolio (the 50-50 or 30-70 stock, bond mix) is the best protection in a bear market.
However, what this snippet of research doesn’t tell us is how well these sample portfolios did in bull markets.
I don’t have the percentages, but it is clear that the portfolios with the larger percentage of stocks would have a higher return than the other two.
The lesson here is if you are years (more than five) away from needing your money, a portfolio more heavily weighted with stocks makes more sense.
If you are approaching or are in retirement, a more conservative posture is warranted.
Bear markets will happen.
Investors should balance their need for return with the risk of a sustained declining market keeping in mind when they will need to tap their portfolio for living expenses or other cash needs.