What Is a Bear Market and How Should You Invest in One?

It is common knowledge among investors that a bull market is one in which stocks have gone up, and a bear market is one in which stocks have fallen. But what exactly defines a bear market?

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Bear with brown fur growling with a snowy background behind it. — Image source: Getty Images.

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To be precise, two things generally need to occur before a new bull market can be declared: A recovery of 20% or more from recent bear market lows and new all-time highs in the benchmark indexes.

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About the Author

Matt Frankel, CFP, is a contributing Motley Fool stock market analyst and personal finance expert covering financial stocks, REITs, SPACs, and personal finance. Prior to The Motley Fool, Matt taught high school and college mathematics. He holds a bachelor’s degree in physics from the University of South Carolina, a master’s degree in mathematics from Nova Southeastern University, and a graduate certificate in financial planning from Florida State University. He won a SABEW award for coverage of the 2017 Tax Cuts and Jobs Act. He is also regularly interviewed by Cheddar, The National Desk, and other TV networks and publications for his financial, stock market, and investing expertise.

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How to invest in a bear market

Bear markets can certainly be scary times for investors, and nobody enjoys watching the value of their portfolios go down. On the other hand, these can be opportunities to put money to work for the long run while stocks are trading at a discount.

With that in mind, here are some rules you can use for investing in a bear market the right way:

Think long term: One of the worst things you can do in a bear market is make knee-jerk reactions to market movements. The average investor significantly underperforms the overall stock market over the long run, and the primary reason is moving in and out of stock positions too quickly. When stocks plunge and seem as if they'll keep falling forever, it's our instinct to sell "before things get any worse." Then, when bull markets happen, and stocks keep reaching new highs, we put our money in for fear of missing out on gains. It's common knowledge that the main goal of investing is to buy low and sell high, but by reacting emotionally to market swings, you're literally doing the opposite. Invest in stocks that you want to own for the long run, and don't sell them simply because their prices went down in a bear market.

Focus on quality: When bear markets hit, it's true that companies often go out of business. One of my all-time favorite Warren Buffett quotes is, "When the tide goes out, that's when we find out who has been swimming naked." In other words, when the economy goes bad, companies that are overleveraged or don't have any real competitive advantages tend to get hit the hardest, while high-quality companies tend to outperform. During uncertain times, it's important to focus on companies with rock-solid balance sheets and clear, durable competitive advantages.

Don't try to catch the bottom: Trying to time the market is generally a losing battle. One thing to keep in mind during bear markets is that you aren't going to invest at the bottom. Buy stocks because you want to own the business for the long term, even if the share price goes down a little more after you buy.

Build positions over time: This goes hand in hand with the previous tip. Instead of trying to time the bottom and throwing all your money in at once, a better strategy during a bear market is to build your stock positions gradually over time, even if you think prices are as low as they're going to get. This way, if you're wrong and the stock continues to fall, you'll be able to take advantage of the new lower prices instead of sitting on the sidelines.

What Is a Bear Market and How Should You Invest in One?

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