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  • Dollar-cost averaging involves investing a specific amount at a regular fixed interval.
  • Dollar-cost averaging into the S&P 500 index during the Great Recession produced a larger account balance.
  • This strategy is best applied to market indexes rather than individual stocks.

Surviving a bear market depends not only on your financial plan but also on having the fortitude to stick to it. That’s easy during bull markets when everything is rallying, and everyone feels smart. However, it’s tricky in bear markets when everything is falling, and everyone feels dumb. Even sticking with basic strategies like dollar-cost averaging can feel like a herculean task in bear markets. Yet, history suggests that’s precisely what investors should do.

What is Dollar-cost averaging?

Dollar-cost averaging is an investment strategy. Investors select a specific amount of money to invest, then they invest that amount in the same asset in equal and regular installments, such as monthly.

Instead of picking stock market bottoms or tops, these periodic investments are made regardless of the asset’s price. Since dollar-cost-averaging involves a set amount of money, the number of shares in the stock, mutual fund, or ETF purchased varies as the price rises or falls.

For instance, suppose you wish to invest $1,000 per month. If the price is $50 in month one, you’d buy 20 shares. If the price is $40 in month two, you’d buy 25 shares, and if it’s $60 in month three, you’d buy 16.67 shares, leaving you owning 61.67 shares at an average price of $48.65 per share.

Why Dollar-cost averaging in a bear market can be smart

The beauty of dollar-cost averaging is that it reduces the risk of incorrectly buying before a big price drop. If you were to invest the entirety of your money in one trade near the peak of a bull market, you’d endure a substantial decrease in your account balance as prices fall in a bear market.

By spreading your risk over time during a bear market, you reduce your drawdown because you’re buying more shares at increasingly lower prices. As a result, you wind up owning more shares at a lower price when the market finds its footing and starts climbing higher. This can allow your account balance to recover more quickly.

For example, let’s consider how dollar-cost averaging would’ve helped an investor during the Great Recession, when the S&P 500 declined 46% from its peak in October 2007 to its low in March 2009.

Let’s suppose an investor bought $10,000 of the S&P 500 ETF SPY on October 31, 2007, and then dollar cost averaged an additional $100 monthly at the end of every month through 2012.

Altogether, she invested $16,200, comprising the initial $10,000 plus $6,200 in additional monthly contributions. As of December 31, 2012, she owned roughly 154.36 shares at an average dividend-adjusted price of $104.95. The SPY closed that day at $117.98, so her account value was $18,212, giving her a 12.4% gain.

Now, let’s suppose she bought the $10,000 on October 31, 2007, but chose to add $100 monthly to a shoebox in her closet instead. She also set aside $16,200, but she would only have had $16,448 on December 31, 2012. In short, she would’ve barely broken even despite the initial $10,000 having been invested in the market for five years!

The Smart Play

One mistake people make is assuming the market’s historical ability to climb to new highs after a bear market is true for individual stocks too. As a result, they mistakenly dollar-cost average into falling individual stocks, hoping they’ll eventually come out ahead.

The problem with that thinking is that the S&P 500 is a momentum index. Market capitalization determines its holdings and weights, so if a stock’s market cap gets too low, another stock replaces it. As a result, the S&P 500 always reflects the biggest, most successful U.S companies rather than past winners like Sears or Polaroid.

The ever-changing nature of the index means it’s incorrect to extrapolate the S&P’s past ability to recapture former highs to individual stocks. Unfortunately for many, Wall Street’s dustbins overflow with former high-flyers that never regained their peak prices, even decades later. So, it’s best to focus on the market indexes.

Bear markets can also be an excellent time to boost your monthly investments. Increasing how much you're regularly buying during a bear market can result in owning more shares at lower prices, helping your account balance grow faster during the next bull market.

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