Watching the value of your portfolio drop can be tough. It’s even tougher to watch when the market (and / or your portfolio) falls into a bear market territory, defined as a prolonged period of stock prices dropping by at least 20% from recent highs.
But bear markets shouldn’t be the time to panic and start selling off assets. For investors with a long-term attitude about the market and their individual stock holdings, bear markets can actually present an opportunity. Let me explain.
You can lower your cost basis
When markets get volatile and investors are talking about what to do, a phrase that often pops up is “buy the dips.” It’s an investing strategy that can boost your overall return if done properly. If you’re a long-term investor and you have a company you are confident has a lot of potential for stock growth, buying the dip gives you the chance to lower the cost basis of your investment. Your cost basis is effectively the average price of the shares you’ve purchased, accounting for the fact you likely purchased multiple shares at different prices at different times.
If you bought 10 shares of a company at $ 200 each, your cost basis would be $ 200. If the stock’s price decreased to $ 150 and you bought 10 more shares, your new cost basis would be $ 175. Here’s how the math works:
- 10 shares x $ 200 = $ 2,000
- 10 shares x $ 150 = $ 1,500
- $ 3,500 / 20 shares = $ 175 per share
Your cost basis is important because it determines how much profit you receive when you eventually sell the shares. You and someone else could sell the same number of shares at the same time for the same price, but the person with a lower cost basis would collect a higher profit. If the above stock increased to $ 300 and you sold your 20 shares, you’d profit $ 125 per share. If someone’s cost basis were $ 200, they’d profit $ 100 per share.
So, in a bear market, a short-term drop in the price of a stock you planned to invest in any way can be viewed as a discount. If you would have invested in a company at $ 200 per share, if it drops to $ 150, you should still feel comfortable making that investment.
To take advantage of the dips, you need to keep some cash set aside
You can’t benefit from a bear market if you don’t have the cash to purchase the discounted stocks. There’s no single answer for how much cash you should have available, but cash does play an important role in a savvy investor’s action plans.
Imagine you’re an investor and a strong believer in Microsoft (MSFT 2.26%). At the beginning of the pandemic in March 2020, Microsoft’s stock price dropped to around $ 137. At that price, you could have bought 10 shares for $ 1,370. As of May 9, 2022, those 10 shares would be worth over $ 2,650. However, you couldn’t have taken advantage of the price drop if you didn’t have cash readily available to use.
You could sell one investment to purchase another investment, but it’s not a good option and is best avoided. Having dedicated cash set aside for these opportunities (that isn’t your emergency fund) is important.
Focus on the goal
Good long-term investors don’t focus on the daily fluctuations of stock prices. Volatility is, and will continue to be, part of investing; that’s just how it works. If you’re focused on the long term, what’s happening with a stock’s price in the day-to-day shouldn’t be of much concern.
History has shown us that fundamentally sound companies make for good investments over the long term, even if they’re experiencing short-term market downturns. Markets go up and down short-term but they generally go up over the long term. An investing strategy that takes advantage of that notion is a winning one.