When the stock market trends in the same direction for a prolonged period, it's generally classified as either a bull market or a bear market. A bull market occurs when stock prices continuously rise, and a bear market occurs when prices decline for an extended period.
Although nobody likes seeing their retirement savings and net worth decline during bear markets, for many people, there's no need to panic and begin selling their investments. In fact, bear markets can work wonders for your retirement portfolio in the long run.
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Buying the dip
When stock prices begin to drop, you often hear people encouraging others to "buy the dip." For people focused on long-term investing, buying the dip accomplishes one important thing: It brings down your cost basis. Your cost basis tells you how much you've essentially paid for each share of a company you own, accounting for the fact you likely purchased different shares at different prices over time.
If you bought 10 shares of a company at $50 each, your cost basis would be $50. If the stock's price increased to $100 and you bought 10 more shares, your new cost basis would be $75:
- 10 shares * $50 = $500
- 10 shares * $100 = $1,000
- $1,500 / 20 shares = $75
Your cost basis is important because it affects just how much profit you receive when you eventually sell the shares. You and someone else could sell the same number of shares at the same time for the same price, but the person with a lower cost basis would have received a higher profit.
If you truly believe in the long-term potential of a company or fund, whenever prices begin to drop in the short-term, you can view this as a chance to get sound investments at a "discount." If you would invest in a company at $100 per share, if it drops to $80, you should still feel comfortable making that investment.
Cash has an important role
Outside of your emergency fund -- which should be three to six months' worth of expenses -- cash can also play an important role in your investing strategy. There's no concrete answer as to what percentage of your portfolio should be in cash, but a rule of thumb is to at least keep 5% in cash. Having cash readily available in your portfolio allows you to take advantage of bear markets and falling prices.
Imagine you were an investor in ExxonMobil (XOM 0.39%) before the stock market crash at the start of the coronavirus pandemic in March 2020. If you had cash readily available, you could've bought more shares of ExxonMobil for $33 each on March 20, 2020. For $1,650, you could've purchased 50 shares. Those same 50 shares are worth over $4,200 as of April 12, 2022.
Keep your eyes on the prize
The only thing certain in the stock market is uncertainty; trying to time the market is all but impossible to do consistently long term, and the added stress oftentimes makes it not worth even trying. As a long-term investor focused on saving for retirement, you shouldn't let short-term price fluctuations discourage you from continuing to invest.
History has shown us that fundamentally and financially sound companies will find ways to weather bad economic storms and keep their businesses rolling. If you have a while before retirement and can wait out bear markets, you should do just that -- you'll likely be glad you did.
