1 Thing Smart Investors Know About Bear Markets

The S&P 500 came close to entering a bear market earlier this year, but ultimately bounced back before that happened. The Nasdaq Composite wasn't as lucky but it, too, has been rallying recently, and as of Monday's close, it was around 14% away from its recent high, putting it in correction territory, but no longer down more than 20%, which is when a bear market exists.

But the worst is not necessarily over. There's still plenty of uncertainty ahead, and the risk of a recession remains elevated due to tariffs. Investors shouldn't be surprised if both the S&P 500 and the Nasdaq enter bear market territory later this year. And while that may be concerning, for smart investors, they know it can be a time to take advantage of depressed valuations.

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Buying stocks in a bear market can be a great move

If a bear market hits, it can be a stressful time to be invested in stocks; no one wants to see red on their portfolio. And continually looking at your holdings and obsessing about them can lead to stress and result in panic moves, like selling quality stocks just because the market as a whole is doing poorly.

But in trying times, it's the temperament that matters. Warren Buffett doesn't believe you need to be a genius to outperform the market. Instead, he says what matters is having a good head on your shoulders. "The most important quality for an investor is temperament, not intellect. You need a temperament that neither derives great pleasure from being with the crowd or against the crowd."

A good example of a struggling stock that has a quality business is Nvidia (NASDAQ: NVDA). The chipmaker is a leader in the artificial intelligence (AI) revolution. Its chips are used by major tech companies and businesses involved with developing AI technologies, including chatbots. It's a leader in the AI chip market, and that has allowed the company to generate massive gains over the years. Even when including this year's downturn in the market, the stock's five-year gains are an impressive 1,400%. Put another way, that would have turned a $10,000 investment in the stock five years ago into around $150,000 today. Those are life-changing returns.

This year, however, Nvidia is down around 20%. The business hasn't suddenly lost a lot of revenue or customers nor are the long-term growth prospects for AI suddenly dwindling. Sure, there is the possibility that tech companies may cut back on their AI spending in the near future, especially if a recession weighs on their earnings. But the long term remains promising, and Nvidia is a leading company in AI. The stock's decline means it now trades at a price-to-earnings multiple of 37 -- it was more than twice as expensive (with respect to earnings) in the early part of last year.

Smart investors know that buying shares of Nvidia right now could allow them to secure some great returns; it's much better than loading up on it when it was at all-time highs. This is the type of stock, given all of its fantastic growth potential, which may be a good buy any time there's a sharp decline in its valuation, because there's a high likelihood that it will recover -- it's just a matter of how long that will take.

Not sure what to buy? Hold a position in the S&P 500

You may not be all that convinced of investing in Nvidia or any other growth stock, simply because you want to minimize your risk. If that's the case, a good alternative is to invest in an exchange-traded fund (ETF) that tracks the S&P 500. That will give you exposure to the top stocks on the markets.

An ETF which does that is the SPDR S&P 500 ETF Trust (NYSEMKT: SPY). It has an expense ratio of just 0.09% and provides investors with an easy way to track the S&P 500's performance. Historically, the broad index has averaged an annual return of around 10% per year. But after hitting record highs recently, it was getting a bit expensive, and it may have been due for a bit of a correction. At the very least, buying the SPDR S&P 500 ETF Trust around its high could have resulted in you earning lower-than-average returns over the long run.

The decline in the market in recent weeks, however, created an opportunity to invest at a much lower price. When global tariffs were announced in April, this SPDR ETF fell to around its 52-week low. It has recovered since then, but it's a good example of when buying the ETF amid such a rapid sell-off may have been a no-brainer move.

While the market may seem like it's in an endless tailspin when a sell-off is taking place, it's that steady temperament that is important and that can ensure you make smart decisions, rather than panicked ones.

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David Jagielski has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Nvidia. The Motley Fool recommends Nasdaq. The Motley Fool has a disclosure policy.