Bear markets can be anxiety-inducing for investors. When share prices begin to drop, investors can see large amounts of their net worths erased in the course of only a few trading days.
However, there can also be substantial upsides to market downturns for investors who are willing to play the long game and not worry about short-term market fluctuations.
Here’s how to boost retirement income by using bearish market conditions to your advantage.
Why Should You Keep Investing in a Bear Market?
The power of bear markets in boosting your retirement income stems from the opportunity to buy stocks at discounted prices.
Assuming you plan to buy and hold for the long-term, lowering your cost basis is a great way to maximize your profits when you eventually do sell your shares. It’s important to approach buying in a bear market with a long-term view, however, as you could always lose money in the short run if the market continues to move lower.
For example, suppose you normally purchased shares in a company for an average of $100 apiece and would ultimately sell them in several years for $200. Now, consider a bear market that caused the stock to slide by 20 percent, lowering the cost basis for some of your shares to $80.
Simply by buying during this bear market, you would be able to raise the profit on some of your shares from $100 to $120. This is obviously a simplified example, but it does show how powerful investing in a bear market can be. This is also a large part of the reason that dollar-cost averaging is such an effective long-term investment strategy.
By taking advantage of the lower prices in bear markets, you can help your portfolio grow more quickly and ultimately reach financial independence sooner.
It’s important to remember, however, that you can’t always time the market. Investing consistently over time is an important part of building wealth in the stock market. When bear markets arrive, however, they can provide investors with unique opportunities to achieve outsized returns.
Where Dividends Come Into Play
As you can see, buying stocks when prices are low in a bear market is great for boosting your overall returns. It also has the power to increase your retirement income by allowing you to buy more shares in dividend-paying companies for the same amount of cash. This, in turn, lets you collect more dividend payouts than you otherwise could going forward.
Returning to the example mentioned above, a $10,000 investment made while the stock trades at $80 would give you 125 shares, as opposed to the 100 you would be able to buy at $100 apiece.
For this example, though, let’s suppose that the stock pays a consistent dividend yield of 2.5 percent and that you choose to hold your shares for dividend income rather than selling them. When the stock eventually hits the $200 you would otherwise sell at, each share would pay $5 annually in dividends.
The shares purchased during the downturn, then, would generate $625 in income every year. By contrast, the same amount invested when the stock traded at $100 would produce only $500 each year.
In addition to providing you with a stable source of income in retirement, dividend stocks can also help you protect your portfolio from future market shocks.
Overall, dividend-paying stocks tend to fare better during bear markets than growth stocks. While growth-oriented portfolios can incur heavy losses when markets turn south, portfolios constructed to produce large amounts of dividend income will be more likely to remain stable and continue generating at least some returns for investors.
How to Invest in a Bear Market for Maximum Retirement Income
Although buying dividend-paying stocks in a bear market can be a good way to boost your income in retirement, it’s still important to pick the right companies to invest in. As with any kind of investing, there are multiple approaches to buying discounted stocks for future income.
One of the simplest strategies for leveraging bear markets to your advantage is to buy discounted shares in dividend aristocrats. This category of stocks includes companies that are part of the S&P 500 and have raised their dividends for a minimum of 25 consecutive years.
These companies tend to be stable and focused on generating enough cash flow to continue raising their dividends. The long-term history of consistently raising payouts makes these stocks the gold standard when it comes to generating dividend income.
A similar but slightly more nuanced investment strategy you may want to consider is dividend growth investing. In a dividend growth strategy, stocks are selected for the speed at which their dividends are increasing in order to maximize future income. It should be noted that some dividend aristocrats are suitable for a dividend growth portfolio. Others, however, raise their payouts very slowly.
Another very simple approach is to buy an ETF made up of high-yield dividend stocks. Vanguard’s VYM fund, for example, consists of 445 stocks that offer higher-than-average dividend yields. Buying a dividend ETF makes it easy to achieve diversification and take advantage of a broad cross-section of dividend-paying stocks.
The Critical Role of Cash
Whether you’re planning to buy in a down market for dividend income or just for larger future returns, it’s important to keep enough cash on hand to buy discounted shares in the first place. This brings us to the question of how much cash you should have in your portfolio to be able to take advantage of bear markets without incurring too much opportunity cost.
Having a large cash reserve waiting for the right investment to come along has been a favorite strategy of many successful investors, most notably Warren Buffett. For investors with lower net worths, however, piling up cash may not always be an optimal strategy.
The best balance of cash in a portfolio is likely 10-20 percent. This amount of cash gives you the option to invest in favorably priced shares without keeping too much of your money out of the market at any given time. Having a cash fund handy in case an attractive investment opportunity comes up will help you take advantage of good buys when the time is right.
While bear markets can be concerning, they also present rare opportunities for investors who are able to get over the fear of loss and take calculated risks. With the right strategy and a reserve of cash on hand, you can turn the negatives of a bear market to your advantage and set yourself up for more income in retirement.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.