What is a bear market and how can you survive one?

The origin of the term ‘bear’ in the context of markets is unclear. It is thought to come from 18th-century hunters selling bear skins before catching their prey in the anticipation that prices for them might fall. Whatever the starting point, bear markets have come to be associated with those that believe markets are going to go down, or with the price action itself.

It’s important to remember, though, that bear markets are a normal part of investing. They happen from time to time, but it’s hard to predict when and why. They are only obvious in hindsight when the warning signs suddenly look clear as day. Yet in the long term, they can also present good opportunities to acquire assets as others despondently sell.

It’s not easy to do that of course. In fact, it’s one of the biggest challenges you face as an investor.

Bull market vs bear market

Investing feels fun in a bull market, characterised by the rising of prices and the expectation that they will continue to rise for an extended period. Seeing the value of your investments grow is rewarding and offers proof you were ‘right’. It seems appropriate to invest some more. A bear market turns the feel-good factor around, as the price of investments drop and, in some situations, plummet. Confidence gives way to doubt. Committing money to invest is beneficial in the long term but is mentally taxing when prices grind lower. Investing feels uncomfortable and it’s easy to lose interest or give up.

That tends to be the wrong reaction though. Decisions made in a bear market can be really important in the longer term. Those that threw in the towel during the Dotcom crash (which lasted 18 months, during which the S&P 500 fell 57%) or the Global Financial Crisis (which lasted 2 years, during which the S&P fell 49%) will have regretted that decision when things turned around. In the 14 years following the crisis the broad US market rose sixfold and the Nasdaq over twice that.

How to invest in a bear market

Another way to think about bear markets is that they blow excess froth and complacency away. Highly-priced assets with overly optimistic projections built in come back down to earth. Those using inappropriate levels of debt or an overconcentration of investments to juice return are exposed. More resilient, diversified portfolios do inevitably take a hit, but they live to fight another day – and harness the next bull market.

On encountering an actual bear in the wild, the general advice is to not panic and to stand your ground – contrary to our natural instinct to run. Similarly, the flight response is not helpful when investing. It generally involves two decisions, selling and then rebuying, and it is fiendishly difficult to get these right. Plus you’ll stop the flow of income from dividends and interest from your investments.

It’s therefore generally best to resist the urge to trade the choppy and volatile markets or make hasty changes that undermine the longer-term objectives of your investment portfolio. However, if the bear market is a wake-up call that it wasn’t sufficiently diversified then consider taking measured action to ensure you have a better balance going forward.

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