Who’s Afraid of a Bear Market?

We made it through October, without much volatility this time – what a change compared to last year! We even got to a new all-time high in the S&P 500 in the last few days. When you reach new records, the pessimists come out of the woodworks and declare that “this is the top” and the next bear market must be right around the corner! It’s like clockwork! And if you go to the popular forums and Facebook Groups in the FIRE community, you’ll see people poking fun at the perma-pessimists. Quite appropriately, I think!

Even if we’re at a top, we’ll have another top before too long! Source: Twitter.com, StockCharts.com

But why are people still a bit nervous about corrections and bear markets and market crashes? Being retired now, I have to admit I feel at least a little bit uneasy right now. Why’s that? If I wanted to quantify how afraid I am of something I’d do so as follows: Fear depends on both the probability and the magnitude of something scary happening:     FEAR = The probability of something scary  TIMES  the magnitude of something scary

In my recent post My thoughts on the “Upcoming Recession” I wrote about the probability part. I personally don’t think that the economy is at the brink of a major slowdown (yet) and with the economic growth trend, still intact the stock market will likely chug along. This all looks like a mid-cycle, temporary soft spot.

What makes me nervous about the bear market prospect, though, is the magnitude part; the fact that IF a bear market were to occur (however unlikely that may be) we’d most definitely go through some anxiety for a while. That’s true for all retirees and even folks close to retirement. Probably not so much for everybody just starting out in their accumulation phase, see the post “How can a drop in the stock market possibly be good for investors?” from earlier this year.

Quite intriguingly, though, if you look around in the FIRE community I get the sense that people minimize how scary a bear market will be if it were to start today. And the thought process is:

  1. The market will always recover (see the chart above)
  2. Most bear markets last only about one to two years

It sounds like the bear has really lost its teeth! So, why am I not convinced? There are multiple problems with that line of thinking. That 1-2 years estimate wildly underestimates how long it takes to recover from a bear market.  If you do the math right a bear market will appear a lot scarier than it’s commonly portrayed. Let’s see why…

Problem 1: Ignoring the time it takes the market to recover

The average bear market may last only about 1-2 years. That doesn’t sound so bad. But what people routinely ignore is that the length of the bear market is defined as the time from peak to trough only. How long will it take to get back to the old peak? Well, let’s look at an example. Here’s the cumulative return chart for the S&P 500 index (Total Return, so dividends are reinvested) after the year 2000 market peak. I do this whole analysis based purely on monthly data, so with the intra-month highs and lows, you might get slightly different results but qualitatively still very similar! The bear market took 25 months. But it takes another 4 years to just get back to the old peak! That means your portfolio was underwater for more than 6 years.

AfraidOfBearMarket Chart01
Cumulative return of the S&P 500 TR after the August 2000 peak. The bear market took 25 months. But it takes another 4 years to just get back to the old peak!

OK, that was one recession and one bear market. How about others? In the table below, I gathered data for 10 major market drawdowns (20%+) since the Great Depression: The market peaks occurred in 1929, 1937, 1946, 1961, 1968, 1972, 1980, 1987, 2000 and 2007.    (side note: I’d consider February 1937 a new peak because we came really, really close to a new peak if you account for dividends and the CPI adjustments, which were negative due to deflation in the 1930s. The price index in nominal terms didn’t even come close to recovering until much later!!!)

I report this both for the S&P 500 price index but also for the more meaningful Total Return Index, i.e., with dividends reinvested. Notice how the average bear market took around 16 months, but from peak to trough to a new all-time high took 56 months on average. About 3.5 times longer than the initial bear market. It seems the stock market is about 2.5-times slower on the way back up than on the way down!!!

AfraidOfBearMarket Table01
Ten bear markets: length of the drawdown vs. length to recovery. Worst 5 = 1929, 1937, 1968, 1972, 2000. Benign 5 = rest.   Note: I count 2007 as a “benign recession” in the context of Sequence Risk because the recovery was so strong and swift! The Worst vs. Benign was not meant as the worst drawdown.

So, just right off the bat, that mantra “nothing to worry about, the bear market will be over quickly” seems like a bit of false advertising. You’ll be underwater for an average of almost 5 years, instead of one to two years! And remember, from a Sequence of Return Risk perspective it’s the time you spend below the peak that will create problems with your retirement strategy, not just the length of the equity drawdown!

But it gets even worse, which brings us to the next point:

Problem 2: Ignoring Inflation (again!!!)

Recall my post from a few months ago: “How To “Lie” With Personal Finance” where Lie #2 deals with the way we sometimes delude ourselves if we ignore inflation. If your expenses increase during that time due to inflation, you want your portfolio to not just catch up with the old all-time high, but with that all-time high plus inflation. How long would that have taken after the year 2000 stock market peak? That’s in the chart below. Shockingly, the 2002-2007 bull market was only enough to reach a new high in 2007 in nominal terms. But that level still had a negative real rate of return; the blue line never gets back to the yellow line! Then the 2007-2009 recession and bear market hit and took your portfolio to the woodshed again. You would have returned to your August 2000 portfolio level only in April 2013(!) when adjusting for inflation! Almost 13 years later.

AfraidOfBearMarket Chart02
For the S&P 500 to catch up with the old all-time high plus CPI inflation would have taken almost 13 years!

How about the other bear markets? In the table below, I report the results for the Total Return Index. So, 82 months on average, just under seven years. And that’s the average. Around the really scary bear markets (1929/1937, the 1970s and 2000) we’d spend anywhere between 12 to 15.5 years underwater.

AfraidOfBearMarket Table02
S&P 500 Total Return Index. Months after the market peak to reach 1) the trough, 2) the old market peak and 3) the old market peak adjusted for inflation.

So, picture yourself as a buy-and-hold investor having to wait 5 years (or 10+ years in the bad bear markets) for your portfolio to recover. It wouldn’t necessarily ruin you financially, but missing out that many years of market gains is a major opportunity cost. Nothing to take too lightly!

And you’re even worse off if you’re a retiree, due to Sequence of Return Risk! And talking about retirees, this spells trouble for all the folks who claim that the simple solution to Sequence Risk is to just keep a “cash bucket,” i.e., a certain number of years worth of expenses in non-risky assets (money market, CDs, government bonds). Well, unfortunately, 16 months’ worth of expenses – the length of the bear market – will not suffice. 56 months of expenses (back to the new all-time-high) will not suffice. You’ll need about 82 months of expenses to cover just your average bear market, significantly longer in the really bad bear markets!

But even that 82-month cash bucket is not enough, which brings me to the next point…

Problem 3: Ignoring that a 0% real return still really, really sucks!

Well, OK, the recovery takes a little longer than the 1-2 years normally floating around. But 82 months is still not that long, right? We just have to keep about 7 years worth of expenses in the cash+bond buckets and then we’ll be OK. With a 4% withdrawal rate that makes 28%. So, why not have 72% in stocks and 28% in a money market fund? Then we should be completely protected from Sequence Risk if an average bear market hits, right?

Wrong! The bucket proponents routinely miss one crucial detail! Let’s look at the following example: Imagine you start with a $1,000,000 portfolio. You put 72% or $720,000 into equities and 28% or $280,000 into your cash bucket yielding about enough to keep up with inflation (not a bad assumption right now). You withdraw $40,000 a year adjusted for inflation from the safe asset bucket. You never had to touch your equity portfolio while it was underwater. So, why haven’t we succeeded in hedging against Sequence Risk? Well, if the equity portfolio only just returns to its old all-time high in CPI-adjusted terms after 7 years, we now have an equity portfolio worth $720,000 (in year 0 dollars) but we’re withdrawing $40,000 p.a. (in year 0 dollars).

Do you see a problem with that? We now have a 100% equity portfolio and a 40/720=5.56% withdrawal rate! Simply returning to a new all-time high in your equity portfolio is not enough, not even if adjusting for inflation! You also have to replenish your diminished cash bucket before the next big bear market as well! So, to make it back to a $1m portfolio, your equity portion should have grown by roughly  (1000/720)^(1/7)-1=4.8% over and on top of inflation to make it back to the initial portfolio level. In other words, just to keep up with the withdrawals from the cash bucket, my equity portfolio has to work much harder than 0% for 7 years. You need about a 5% return after CPI inflation!

So, let’s see how long it would take for the equity portfolio to not just recover in real, CPI-adjusted terms but even add roughly 5% per year. So, we take the same chart as before and add another line “CPI+5% p.a.” in green, see below. Bummer! After the 2000 market peak the S&P 500 never even got back to the old trend path! 229 months and counting! Ouch!

AfraidOfBearMarket Chart03
Since the August 2000 high, the S&P 500 total return index never even came close to recovering to the CPI+5% growth path!

Well, the good news is that, during all of the other bear markets, the S&P 500 indeed managed to catch up to the CPI+5% growth path. But in some cases, it took forever. I mean F-O-R-E-V-E-R! 26 years in the Great Depression. 27 years in the 1960s! And these are, no coincidence, exactly the recessions and bear markets where the 4% Rule failed and even the cash bucket strategy would have had trouble saving the 4% Rule.

AfraidOfBearMarket Table03
The recovery to a CPI+5% growth path takes much longer!

Talking about bucket strategies, the discussion wouldn’t be complete without mentioning my good blogging friend Fritz Gilbert over at The Retirement Manifesto who is a big fan of a bucket strategy. But, to my knowledge, Fritz doesn’t claim that the bucket strategy will ever solve Sequence Risk. It may alleviate it a bit but never eliminate Sequence Risk. That’s consistent with my findings both in my Safe Withdrawal Rate Series. See Part 19, Part 20 (glidepaths, i.e., liquidating bonds first during the bear market, so very similar to a bucket strategy) and Part 25 (some explicit cash bucket simulations). So, just to be sure, when I say, some people are wrong about bucket strategies, I wasn’t talking about Fritz! 🙂


Again, I’m not saying a bear market is around the corner. It’s a low-probability event. But IF a bear market were to occur, it’s a lot scarier than people want to make it. True, the market has always recovered! It will also recover following the next bear market. The bad news: it’s not really a matter of if, but when! If the recovery takes too long it spells trouble for investors and especially retirees! For retirees with an aggressive withdrawal rate, it might make the difference between making it and running out of money. If you have a more conservative withdrawal rate – yours truly included – it might make the difference between having tons of money left over and just scraping by.

The average bear market may last for only 16 months, but the recovery will last a lot longer. The anatomy of the average bear market looks like the one below. For the severe bear market events (1929, 1937, 1968, 1972, 2000), expect to double the time it takes to recover.

If you’re not scared yet then I don’t know what it would take. But, of course, there’s always Halloween right around a corner…

AfraidOfBearMarket Chart05
The anatomy of the average bear market. Don’t believe the B.S. about how short the bear market might be and every bear will always recover!

Are you scared about a bear market? Please leave your comments and suggestions below!

Title picture credit: Pixabay.com

182 thoughts on “Who’s Afraid of a Bear Market?

  1. I wonder how many of “us” sold in the last downturn. Most of my non-financially-educated friends sold. And almost all them never got back end. They don’t listen to reason…

    1. Scary to think about that. I tried to talk most of my friends out of selling, but not everyone followed that advice. But I think the FIRE community must have done well through this. Some nice buying opportunities in March and April! 🙂

  2. Would love to see an update of the 8-2000 market peak to know if it’s full recovered yet or not, and an updated graph to see how much it’s changed. Enjoy this data, just hoping for an update since it seems like the market might have made up some ground on the full recovery plus CPI +5%.

      1. Would love to see an update to this post given all that’s happened in 2022, when bond lost just as much value as equities.

        1. Well, so far it looks like a benign bear market. Both 2020 and 2022 saw a very swift recovery.
          I will sit back a little bit longer because maybe the worst is yet to come in 2022/23. Who knows how crazy the Fed will have to go! I will write an update when I know more! 🙂

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