7 Investing Strategies to Prepare for Bear Markets

by Charles Schwab & Company

Bull markets can run for a long time—but they can’t run forever. And when a bull stops running, it’s better to be prepared than surprised. So how do you prepare? Here are seven things to do:

1. Know that you have the resources to weather a crisis. "Some people panic in a bear market because they don’t know whether they have enough cash to handle near-term goals," says Mark Riepe, Managing Director of the Schwab Center for Financial Research. Ideally, you won’t have to face this question in a crisis—because you should know the answer.

If you’re retired, knowing that you have the next 12 months of living expenses in a bank account or money market fund—and a few more years’ worth in bonds that mature when you need the money—can help keep you calm and clear-headed, Mark says.

"You’re going to react a lot differently than someone who gets blindsided and has never laid that groundwork. It’s not just about your risk tolerance, which is your ability to emotionally handle big price swings and losses," he adds. "It’s about your financial capacity to handle risk. In other words, can you afford to take a loss?"

You might feel risk tolerant, but if you haven’t structured your investments to handle a sharp drop, you may have to make painful adjustments to your lifestyle when the crisis happens.

2. Match your money to your goals. Map out a plan that takes into account what you’re saving for, whether near-term expenses or future financial goals like college tuition or retirement. Structure your portfolio to match those goals.

Money that you’ll need in the short term or that you can’t afford to lose—the down payment on a home, for example—is best invested in relatively stable assets, such as money market funds, certificates of deposit (CDs), or Treasury bills. Goals that need funding in three to five years should be addressed with a mixture of investment-grade bonds and CDs. For money you won’t need for five or more years, consider assets with the potential to grow, such as stocks, which are more volatile.

3. Remember: Downturns don’t last. The Schwab Center for Financial Research looked at both bull and bear markets for the S&P 500^® Index going back to the late ’60s and found that the average bull ran for about six years, delivering an average cumulative return of over 200%. The average bear market lasted roughly 15 months, delivering an average cumulative loss of 38.4%. The longest of the bears was a little more than two years—and was followed by a nearly five-year bull run. The shortest was the pandemic-fueled bear market in early 2020, which lasted a mere 33 days.

How does this impact your bear market kit? Even if you find yourself headed into the second year of a bear market, remember that it won’t last. No bull market endures forever; neither does a bear. And historically, the market’s upward movement has tended to prevail over the declines long term.

4. Keep your portfolio diversified. Let’s say there is a slump—is there a remedy to help your portfolio get back on its feet?

Being well diversified can help cushion against losses. In every bear market there are likely certain segments of the markets that get hit much harder than others. It’s extremely difficult to forecast these ahead of time, so a preventive measure you can take now is to diversify within the equity market as well as across asset classes. Consider the assets you’ve set aside for medium-term needs or goals. Being diversified means you have a wide variety of investment-grade bonds—corporate, municipals, Treasuries, and possibly foreign issues. And they should have varying maturity dates, from short-term to mid-term, so you always have some bonds maturing and providing you with either income or money to reinvest.

Your long-term assets should be divvied up among a wide array of domestic stocks—big and small, fast-growing and dividend-paying—as well as international stocks, real estate investment trusts (REITs) and commodities, says Mark. That mix gives you exposure to asset classes that tend to move at different times and speeds, he says.

5. Don’t miss out on market rebounds. "It’s easy to say that risk doesn’t bother you when the markets are near all-time highs," says Mark. "A better indicator is how you behaved in the last downturn."

Many investors sold at the bottom of the market in March 2009, turning temporary paper losses into real, wealth-crushing losses. Mutual fund outflows were about $21.6 billion that month, according to the Investment Company Institute. Investors who failed to get back in the market in a timely fashion would have missed the beginning of one of the strongest bull markets in history.

To get a sense of what’s at stake when you pull out of the market, even temporarily, during the average bear market, the Schwab Center for Financial Research compared the returns from four hypothetical portfolios:

• One that remained 100% invested in stocks as the market touched its bear-market low and then rebounded. (While we recommend diversifying your portfolio with a mix of assets appropriate for your goals and risk tolerance, we're focusing on stocks here to illustrate the impact of market timing.)
• One that was diverted to short-term T-bills for a month after the market bottomed before returning to a 100% stock allocation.
• One that was diverted to T-bills for three months after the market bottomed before returning to a 100% stock allocation.
• One that was diverted to T-bills for six months after the market bottomed before returning to a 100% stock allocation.

As you can see in the table below, the all-stock portfolio was the best performer and was still delivering higher returns than the other portfolios three years after the market bottomed. But investors in that all-stock portfolio had to stay invested at literally the lowest point of the market cycle. Those who waited until the skies were clearer (e.g., a month after the low point of the cycle, or three months, or even six months) still participated in the recovery, but at a far smaller rate.

Timing the market is very difficult—no one knows for sure when the bottom will come—so if you can tolerate it, riding out a bear market may be worth it.

6. Include cash in your kit. Cash is one of the lowest returning asset classes, but don’t let that blind you to its long-term potential as an agent of diversification in your portfolio. Cash has a very low correlation to other asset classes, so it can offer protection against volatility. Another advantage: Cash reserves can come in handy in down markets. With cash you can buy in when prices are attractively low—without having to sell securities at a loss, if they are also at a low point. So cash can provide your portfolio with some stability (low correlation, low volatility) and flexibility (to buy new investments without selling old ones cheap).

7. Find a financial professional you can count on. Finally, your bear market kit could benefit from having a built-in buddy system, so to speak. Meaning, if you’re not sure how to structure your portfolio correctly, or you think you’d be tempted to do something rash in a market slide, you should find a financial professional you trust to collaborate with you. That person can walk you through a complete portfolio review and help prepare you and your portfolio for times when the market gets tough.