History Says This Is the Smartest ETF to Buy During the Next Bear Market

The S&P 500 index suffered a 37% decline in 2008 and a 26.5% rebound in 2009. Investors who held through both years still lost 20.3% after reinvesting dividends, underscoring the importance of the price paid during a bear market. For those considering an ETF during the next bear market without needing to predict sector outperformance, the Vanguard S&P 500 ETF (VOO) is a potential option.

The Vanguard S&P 500 ETF mirrors the S&P 500, which entered a bear market in July 2008, eventually losing 56.8% from its October 2007 peak. The ETF began as a 2010 offering, yet this history reveals the potential downside of entering a bear market early. During the 2022 bear market, the S&P 500 dropped 18.1%, while the ETF fell 18.2%.

However, the ETF rebounded 26.3% in 2023, with a cumulative return of 3.3% including dividends. This indicates that buying during a bear market does not guarantee quick gains and requires considering whether lower prices reflect potential earnings declines. The Vanguard S&P 500 ETF offers exposure to major U.S. companies across various sectors, with low annual expenses at 0.03%, or $3 per $10,000 invested.

Unlike more sector-specific ETFs, it is not heavily reliant on a single sector, making it suitable for investors who cannot predict which industries will outperform. However, it is not equally weighted, with the top 10 holdings accounting for 39.1% of assets as of Sept. 30. The top holdings, particularly technology companies like Nvidia, Apple, and Microsoft, significantly influence the ETF's performance.

If the S&P 500 falls by 20% during a future bear market and earnings estimates remain unchanged, the ETF's P/E ratio would drop to 14.2. If earnings estimates also fall 20%, the P/E ratio would remain at 17.7. Despite lower prices, investors would still pay the same multiple of expected earnings. Therefore, a falling market does not necessarily mean stocks have become cheaper relative to their earnings prospects.

Buying the Vanguard S&P 500 ETF during the next bear market could be a good choice if share prices decline significantly without a similar drop in the long-term earnings prospects of its holdings. However, waiting for the next bear market also carries risks, as the S&P 500 could rise significantly before one occurs. Nonetheless, the Vanguard S&P 500 ETF provides a way to invest across different sectors without needing to predict which one will outperform.