Which Mutual Funds Are Best in a Bear Market?

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Before preparing your portfolio for a bear market, note that absolute market timing is not recommended for any investor, no matter their knowledge or investing skills. Not even the best professional money managers have consistent success navigating the complexities of capital markets and economic conditions. But that doesn't mean that you shouldn't learn to be prepared to invest in both bear and bull markets. 

Key Takeaways

  • The consumer staples sector, also known as noncyclical, typically does well during recessions. 
  • Gold and precious metal fund also tend to perform well as they’re seen as more reliable than other investments. 
  • Bond prices move in the opposite direction of interest rates, so bond funds are also worth considering in a bear market.

Stocks and Sectors

When interest rates are on the rise, the economy is typically nearing a peak, as the Federal Reserve raises rates when the economy appears to be growing too quickly, and thus inflation is a concern. Those who aim to time the market with sectors have the goal of capturing positive returns on the upside while preparing to protect against harder declines when the market turns down.

Therefore, traders and investors may consider sectors that tend to perform best (fall in price the least) when the market and economy head downward.

Consumer Staples Sector

Consumer staples are also known as "noncyclical." People still need to buy groceries and other products for daily living, collectively called consumer staples, when a recession hits.

Health Care Sector

Like consumer staples, consumers need medicine and go to the doctor in both good and bad times. This necessity is why the healthcare sector may not get hit as hard in a bear market as the broader market averages.

Gold and Precious Metals

When traders and investors anticipate an economic slowdown, they tend to move into funds that invest in real asset types, such as gold funds, that they perceive to be more reliable than investment securities, currencies, and cash.

Bond Funds

Bond prices move in the opposite direction as interest rates, and some bond types can minimize interest rate risk in bear market conditions:

Short-Term Bonds 

Rising interest rates make bond prices go down, but the longer the maturity, the further prices will fall. Therefore the opposite is true: bonds of shorter maturities do better than those with longer maturities in a rising interest rate environment because of their prices.

Keep in mind that "doing better" may still mean falling prices, although the decline is generally less severe.

A few bond funds that work well include PIMCO Low Duration (PLDRX) and Vanguard Short-Term Bond Index (VBISX). The VBISX is no longer open to new investors. You could instead invest in the lower-cost Vanguard Short-Term Bond Index Fund Admiral Shares (VBIRX) or the Vanguard Short-Term Bond ETF (BSV). The expense ratio for VBIRX is 0.07% and the minimum initial investment is $3,000.

Intermediate-Term Bonds 

Although the maturities are longer with these funds, no investor knows what interest rates and inflation will do. So, intermediate-term bond funds can provide a good middle-of-the-road option for investors who wisely avoid predicting what the bond market will do in the short-term.

Even the best fund managers sometimes believe that inflation, and lower bond prices, will return along with higher interest rates, making short-term bonds more attractive. But sometimes they're wrong, and those fund managers lose to index bond funds.

You can also try a more diversified approach with a total bond market index Exchange Traded Fund (ETF), such as iShares Core U.S. Aggregate Bond (AGG).

Inflation-Protected Bonds 

Inflation-protected bonds—also known as Treasury Inflation-Protected Securities (TIPS)—can do well just before and during inflationary environments, often coinciding with rising interest rates and growing economies. A few standouts for TIPS funds include Vanguard Inflation-Protected Securities Fund (VIPSX) and PIMCO Long-Term Real Return (PRAIX).

Defensive Sectors

Sector funds focus on a specific industry, social objective, or industrial sectors such as healthcare, real estate, or technology. Their investment objective is to provide concentrated exposure to specific industry groups called sectors.

Defensive sector funds invest in sectors that may perform well related to other industries during a period of market or economic weakness, such as a bear market or a recession, respectively. Examples include stocks of companies that sell consumer staples like food and medicine, or utility sector stocks. Another sector that tends to perform steadily in weak market conditions is sin stocks.

Bear Market Funds

Bear market funds are not for everyone. They are mutual fund portfolios built and designed to make money during a bear market, hence the name. To do this, bear market funds invest in short positions and derivatives. Thus their returns generally move in the opposite direction of the benchmark index.

For example, during the bear market of 2008, some bear market funds were up 69% as of October 2008, whereas the S&P 500 dropped in value by 37%, which represented a complete inverse return. That said, their returns are often highly volatile, and like with any securities purchase, investors should exercise caution and do their research.

Lazy Portfolio Strategy

For most investors, it can be smart to simply stay out of the market timing and nuanced strategies of attempting to squeeze out every possible bit of return.

Instead, you can diversify with index funds and let the market do what it will, knowing that not even the pros can predict it with any reliable degree of accuracy. One simple example, using all Vanguard index funds, called the "Three-Fund Lazy Portfolio," which has shown positive results over time and through many market conditions.

40% Total Stock Market Index (VTSMX)*
30% Total International Stock Index (VGTSX)
30% Total Bond Market Index (VBMFX)

Above all, do what works best for you.

Note: VTSMX is closed to new investors. You could instead invest in the lower-cost Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX) or the Vanguard Total Stock Market ETF (VTI). The expense ratio for VTSAX is 0.04% and the minimum initial investment is $3,000.