By Ee Hsin Kok. Edited by Arjun Chandrasekar.
Overview
You’ve likely heard of the 2020 stock market crash, the 2007-08 financial crisis, and the DotCom bubble. During these events, the S&P 500 index dropped 36%, 57.7%, and 24.8% respectively. These drops are known as crashes, or bear markets. And though few look forward to them, they are inevitable. This article introduces you to the world of bear markets so you don’t panic when your investment portfolio ultimately has to endure one!
Statistics on Crashes and Bear Markets
A bear market is defined by a drawdown of over 20% in a major index like the S&P 500 (drawdowns less than that are known as ‘corrections’ instead). Since World War II, there has been a bear market about once every 5.4 years, and the most recent one was just last year in 2020. On average, a bear market will last 10 months and the S&P 500 will fall 36% from its high. In contrast, an average bull market lasts 2.7 years and the S&P will gain 112% during the period.
Dealing with Bear Markets
Bear markets are tough to deal with, especially for the ordinary retail investor. Retail investors are often driven by emotion, so when they see large drawdowns, it can stress them out. In fact, a frequent tendency of retail investors is to sell out of fear. This is one of the biggest mistakes in investing. As Warren Buffet once said, “Be greedy when others are fearful.”
Therefore, DO NOT be afraid of bear markets; in fact, think of them as a Black Friday sale! Almost all great companies will be selling at big discounts during a bear market, giving you a chance to pick them up for cheap. Also, remember not to try and time the market. So long as you buy a great business at a good price, you will generate solid returns over the long run. As an example, during the 2020 stock market crash, strong companies like Microsoft, Facebook, and UnitedHealth were selling at 30% discounts to their intrinsic values. They’ve since bounced back, and if you had bought them during the crash, you’d be enjoying triple-digit returns on every one of them right now.
Conclusion
Bear markets are an inevitability in the stock market. They will come about once every 5 years to terrorize your portfolio. But you should not be worried! They usually last less than a year and provide a great opportunity for you to buy fantastic companies at big discounts. Enjoy seeing your portfolio in the red! Sometimes you’ve got to take 1 step back before you take 3 steps forward!
