Investing And Rebalancing In A Bear Market
This article is a guest contribution from Brendan Lee Young of Passiv. Passiv is portfolio management software that makes DIY investing easier. It integrates with users’ brokerage accounts and helps them to automate their portfolio management. With Passiv users can invest and rebalance their portfolios in one-click.
Having a systematic investing plan (and sticking to that plan) is very important.
With that said, market drawdowns make it difficult to stick to these plans from an emotional and psychological perspective. There is something about falling stock prices that make it harder to buy assets – even though they’re getting cheaper day-by-day.
Many young investors witnessed their first bear market in March of 2020 and were unprepared for how to react. In this article, we wanted to publish a guide on investing and rebalancing in a bear market to help prepare you for the market drawdown.
The Importance of a Systematic Investment Plan
One of the best strategies for investing and rebalancing in a bear market need to be implemented before the bear market begins. More specifically, navigating through a bear market becomes significantly easier if you already have a systematic investment plan in place.
What is a systematic investment plan?
It is simply a strategy of how you will invest your personal assets. It includes factors like your asset allocation, your risk tolerance, and how much cash you want to have on hand in your brokerage account.
Having a systematic investment plan is very powerful, but becomes even more powerful when combined with monthly contributions and dollar cost averaging. We discuss these strategies in the next section of this article.
Monthly Contributions and Dollar Cost Averaging
Two other strategies that make it easier to invest and rebalance during a bear market are monthly contributions and dollar cost averaging.
Monthly contributions are exactly what they sound like – adding more cash to your brokerage account each month. It’s best to automate these contributions through automatic payments from your bank account, because this prevents you from neglecting to contribute if you’re having a particularly busy month.
Once these monthly contributions are set up, there is a strategy called dollar cost averaging that is very suitable for pairing with a passive investment strategy.
Dollar cost averaging is the strategy of purchasing the same amount of a specific investment each month. As an example, you could buy $500 of the S&P 500 ETF each month.
This strategy is arguably the best method for investing in a bear market. Since you’re investing the same amount of money each month, you’ll actually purchase more units of the investment when prices are cheap.
Because of this built-in feature of dollar cost averaging, it allows you to easily “buy low and sell high” with no additional effort on your part.
More Advanced Strategies for Investing in a Bear Market
If you are a sophisticated investor (or simply an investor who wants to optimize their investment decisions during a down market), there are other strategies that you can employ while investing or rebalancing during a bear market.
Perhaps the most basic of these strategies is to temporarily increase your monthly contribution. As an example, if you regularly buy $500 of the S&P 500 ETF each month, then you might have increased this amount to $600 temporarily when prices became very cheap in March.
Alternatively, you might chose to tactically modify your asset allocation. Typically this means selling some low-risk investments to buy more high-risk investments.
A common tactic here would be to sell bonds (which generally fall less in price than stocks do during a bear market) to buy stocks. As an example, you might change your 60/40 stocks/bonds asset allocation to 65/35 temporarily, and then rebalance back to your long-term targets once the market has recovered (which usually means that stocks will rebound much more than bonds, allowing you to profit).
What Not To Do During A Bear Market
To close out this article, we wanted to mention mistakes to avoid when investing and rebalancing during a bear market.
First of all, you should avoid making any changes to your systematic investing plan. As an investor who is building a portfolio for retirement, your plan needs to be created based on long-term factors, not short-term fluctuations in asset prices.
Second, you should avoid selling any assets because of psychological or emotional reacts to declining prices. While it’s important to recognize that falling asset prices are scary, you should view them as a long-term buying opportunity in the context of your systematic investing plan.
Lastly, you should avoid using any of the cash you have set aside in your emergency fund to purchase investments while prices are on the cheap. While this is a very tempting strategy, it can leave you extremely vulnerable if you lose your job (knock on wood).
The bear market that occurred in March 2020 was the first market drawdown that many investors experienced. This is especially true for younger investors.
In this article, we discussed actionable strategies for investing and rebalancing in a bear market. The strategies for investing in a market drawdown are not that different from the tactics that you should normally employ when managing your investments – but it’s more important to follow these strategies during bear markets because of the large potential impact it can have on your investment performance.
Here is a brief summary of the information we discussed:
- The importance of having a systematic investment plan (and sticking to that plan)
- Why it’s beneficial to set up automatic monthly contributions to your investment accounts
- What dollar-cost averaging is, and why it’s beneficial to implement it in your portfolio
- Why you might consider increasing your risk tolerance and asset allocation temporarily during a bear market since it allows you to capture more upside when asset prices rebound
- Mistakes to avoid when investing and rebalancing in a bear market