If the Stock Market Drops 20%, History Says This Is What Could Happen Next

A 20% stock market decline can easily feel like the point where it’s time to head for the exits.

After all, a drop of that magnitude, which meets the technical definition of a bear market, can be psychologically damaging. The headlines usually get worse, investor confidence drops, and there’s no guarantee that a 20% loss won’t eventually become a 30% or 40% loss.

But here’s the part that most investors miss. Historically, some of the market’s strongest returns have occurred during recessions and bear markets. Sentiment often turns quickly once optimism returns, leading to big rallies at unexpected times.

If another bear market hits, history suggests that what happens afterward could be much more important to your portfolio than the initial 20% drawdown.

Historically, bear markets have created big opportunities

Fidelity recently took a look at S&P 500 (^GSPC -0.38%) corrections and bear markets between 1950 and 2022. It found that following a bear market bottom, the S&P 500 generated an average return of 37% over the following year.

That’s significantly higher than the stock market’s long-term average annual return of around 10%.

The problem, of course, is that investors never know when the bottom is actually in. It’s only in hindsight that we know where and when the bottom was. That’s why waiting for the perfect buying opportunity usually results in missed gains. Investors usually fear further losses more than getting excited about potential gains.

The better lesson from history that you shouldn’t ignore is that bear markets typically lead to much longer periods of rising stock prices.

Vanguard also examined market cycles between 1980 and 2023. It found that bear markets produced an average loss of 30% and lasted 282 days. Bull markets, by comparison, generated an average gain of 96% and lasted 1,018 days.

In other words, the good times have historically lasted more than three times as long as the bad ones. When investors try to time the market, they usually end up capturing the losses but missing out on the gains.

Here’s what I’d do after a 20% drop

If the S&P 500 falls by 20%, I’d maintain my long-term focus and continue buying the Vanguard S&P 500 ETF (VOO -0.38%) or the Vanguard Morningstar Total Stock Market ETF (VTI -0.32%) regularly.

This process won’t guarantee gains or the avoidance of losses. But it would allow you to capture the rebound when it happens. And it allows you to continue buying shares at lower prices than before, which can enhance your long-term portfolio’s performance.

Bear markets can be painful. Historically, though, the periods following major sell-offs have produced some of the market’s strongest returns. Savvy investors would be wise not to miss out on the opportunities that are presented.