What does the S&P 500 bear market mean to you?

(NerdWallet) – A bear market is defined by a broad market index that is down 20% or more from a recent high. And as of Monday’s market close, the S&P 500 index officially reached bear market territory. That’s down more than 21% since the start of the year.

So what does this mean for you? Bear markets can be stressful for investors of all stripes. But they often affect active stock pickers — people who invest primarily in individual stocks — differently than passive index fund investors.

Here’s what economic experts are saying about the current sell-off and what it could mean for you.

What’s behind this bear market?

“Discretionary spending is gone,” Daniel McKeever, assistant professor at Binghamton University School of Management, said in an email interview.

American consumers are “dipping into their savings, if their savings aren’t already depleted. And ultimately, it will not support stock market growth,” he said.

McKeever, speaker on investments and derivatives markets, said high inflation leads many people to spend less, which means less money in the pockets of businesses. And that leads to the current stock market woes.

“Without some kind of meaningful relief from rising gas and grocery prices…people just don’t have the money to spend,” he said.

The consumer price index has risen 8.6% over the past 12 months, while the S&P 500 has fallen 11.9% over the same period.

These numbers are the same for all investors, regardless of their investment strategy, but they can translate into different returns and levels of volatility for active and passive investors.

What does this bear market mean for active and passive investors?

Active investors, or individual stock pickers, try to beat the market. Passive investors often try to mirror the market.

These active investors “may be better off or worse off during a bear market, depending on their stock picks,” said Eric Nelson, certified financial planner and founder of Independence Wealth, a New Jersey-based registered investment adviser.

Stock picking tends to be riskier (and potentially more rewarding) than passive investing; stock pickers can theoretically beat the market by picking stocks that outperform their indexes. But they can also (and usually do) end up with underperforming market returns by picking stocks that underperform their benchmarks.

Investors in passive index funds will likely see less volatility because they won’t have individual stock risk, Nelson said in an email interview.

This is because when you invest in an index fund, you are investing in a basket of companies which aims to mirror a stock market index, so if a company goes bankrupt due to, say, a bear market, there are still others to energize your portfolio.

McKeever said financial advisers who actively manage portfolios sometimes see themselves as superior to passive investors in downturns, but research suggests that’s not the case.

“Active management does no better than passive management in times of crisis, just as it does no better than passive management over the long term,” McKeever said.

The latest Quantitative Analysis of Investor Behaviour, or QAIB, study from financial services market research firm Dalbar Inc. found that the average stock investor – as opposed to a passive index investor – earned more 10% worse than the S&P 500 in 2021 — the third-largest underperformance on record in the study’s 36-year history.

How to react to a bear market?

Don’t panic, say most financial advisors. If you’re an investor – not a day trader – you’re in it for the long haul, and you know there will be ups and downs. The average stock returnn it’s 10% per year, and yes, sometimes, like in 2022, it’s lower, and sometimes it’s higher. It’s a good rule of thumb to stay invested and resist the urge to pull out of the market on down days like these.

Some investors recommend devoting no more than 10% of a portfolio to individual stocks and keeping the remaining 90% in a diversified mix of low-cost index funds.

If you do this and use purchase averageyou might take a temporary hit, but most likely, if you have a longer time horizon, your portfolio has time to recover.

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