A bear market is a prolonged period in which investment prices fall, accompanied by widespread pessimism. Although figures can vary, a downturn of 20% or more in the Dow Jones Industrial Average or Standard & Poor’s 500 Index for a two-month period, is generally considered to be an entry into a bear market. The most famous bear market in U.S. history was the Great Depression in the 1930s.
Instead of fearing a bear market as many investors do, you should embrace it for several reasons. For anyone who will be investing for years to come, falling stock prices are not bad news because they allow you to buy more stock for less money. The period after a decline in stock prices is actually a safer time to be investing. Dollar-cost averaging, investing the same amount of money every month, will buy you more stock when the market is low than when it is high and this will cause you to end up with a more satisfactory overall price for your stock holdings.
When stock market prices are increasing, the more likely it seems to amateur investors that these stocks will keep going up. But this is flatly contradicted by a fundamental law of financial physics that the bigger companies get the slower they grow. A $1 billion company can more easily double its sales than a $100 billion company. Without bear markets to take stock prices back down, while you’re waiting to “buy low” you might feel left behind and all too often abandon caution and end up “buying high”. The longer a bull market lasts the more easily investors forget that stock prices also fall; in fact during a prolonged bull market many people begin to feel that bear markets are no longer even possible. This is the “unsustainable optimism” side of the stock market pendulum, and at the best, it causes many investors to pay too much for their stock holdings.
Benjamin Graham, widely considered the greatest investment adviser of the twentieth century, taught that you should buy stock when the market is yelling at you to sell. He said that an intelligent investor should never invest because the market has gone up, and never sell because it has gone down. Warren Buffet phrases it this way, “Be brave when others are afraid and afraid when others are brave.” There is an exception to this, however. It could make sense to sell during a bear market if that will create a tax advantage, allowing you to use your losses to offset ordinary income. You will be able to reduce your taxable income and, after waiting the required interval, you could repurchase the stock at the lower price. You would still own stock in the company but now you would own it for less than you paid the first time.
Trying to determine the best time to buy or sell stocks is known as timing the market. This is more of a speculative, riskier strategy than long-term investing. As a long-term investor you should focus on the more fundamental factor of increasing the value of your investment over time. You must understand that reversals are a normal part of the market’s cycle and you must be prepared to wait them out. When you make long-term investments you must avoid emotional short-term reactions to the periodic reversals of the market, or you will lose value in your stock holdings through higher transaction costs, lost opportunities and lost profits.
No matter when bear markets occur, as an intelligent investor you should discipline yourself to realize that the real money to be made in stocks will be made over the long-term.