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

The S&P 500 (SNPINDEX: ^GSPC) index fell 37% in 2008 and rebounded 26.5% in 2009. However, investors who held through both calendar years still lost 20.3%, even with dividends reinvested.

These returns highlight why the price investors pay during a bear market matters. Investors looking to buy an ETF during the next bear market without having to predict which sector will outperform can consider the Vanguard S&P 500 ETF (NYSEMKT: VOO).

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What previous bear markets reveal

The Vanguard S&P 500 ETF tracks the S&P 500, which entered bear market territory in July 2008. The index continued declining until March 2009, eventually losing 56.8% from its October 2007 peak. The Vanguard S&P 500 ETF was launched in 2010, but this history demonstrates the potential downside of buying an S&P 500 ETF early in a bear market.

The 2022 bear market was less severe. The S&P 500 lost 18.1% that year, while the Vanguard S&P 500 ETF declined 18.2%. The ETF subsequently gained 26.3% in 2023, leaving investors who held through both calendar years with a cumulative return of just 3.3%, including reinvested dividends.

Hence, buying during a bear market does not guarantee quick gains. Investors must also consider whether lower stock prices adequately reflect the potential decline in corporate earnings.

Why VOO stands out

The Vanguard S&P 500 ETF provides investors with exposure to major U.S. companies across technology, healthcare, financials, industrials, and other sectors. The ETF's annual expense ratio is just 0.03%, or about $3 for every $10,000 invested.

Unlike the iShares Semiconductor ETF or the Vanguard Energy ETF, the Vanguard S&P 500 ETF does not depend heavily on the performance of any single sector. This makes it a suitable choice for investors who cannot predict which industries will perform best during and after the next bear market.

However, the Vanguard S&P 500 ETF is not equally weighted. The 10 largest holdings accounted for 39.1% of assets as of Sept. 30. Technology companies, particularly Nvidia, Apple, and Microsoft, have a significant influence on the ETF's performance. A technology sell-off could therefore still hurt the ETF significantly.

A lower price may not mean better value

According to FactSet Research Systems' Nov. 6 report, the S&P 500 was trading at 17.7 times its expected earnings for the next 12 months. This is below its five-year average of 19.8 and 10-year average of 19.1.

If the S&P 500 index falls by 20% during the next bear market and earnings estimates remain unchanged, its price-to-earnings (P/E) ratio would decline to 14.2. However, if earnings estimates also fall 20%, the P/E ratio would remain at 17.7. Despite lower share prices, investors would still be paying the same multiple of expected earnings.

Hence, a falling market does not automatically mean stocks have become cheaper relative to their earnings prospects.

Should you buy VOO during the next bear market?

I would prefer buying the Vanguard S&P 500 ETF during the next bear market if share prices decline significantly without a similar deterioration in the long-term earnings prospects of its holdings.

Waiting exclusively for the next bear market also carries a risk, since the S&P 500 index could rise significantly before one occurs. Nevertheless, the Vanguard S&P 500 ETF offers a way to invest across different sectors without having to predict which one will outperform.

Manali Pradhan, CFA has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple, FactSet Research Systems, Microsoft, Nvidia, Vanguard S&P 500 ETF, and iShares Trust-iShares Semiconductor ETF. The Motley Fool has a disclosure policy.