Market Corrections: What to Do When the Next One Hits
Did you notice it? Our article’s title states when a market correction hits, not if. And that’s because it’s almost inevitable that a market correction will occur.
Just because you can expect market corrections doesn’t mean they won’t sting. And if you are unprepared and you panic, they can do more than sting. So here are some dos and don’ts to help you prepare for when the next market correction occurs.
What Is a Market Correction?
A market correction is a drop of at least 10% in a market index. It often starts in response to an event—economic, political, social—that prompts anxious investors to sell off equities.
A 10% drop may sound dire, but corrections are a regular occurrence. For example, the S&P 500 index has had 54 market corrections and bear markets (a 20%-or-more drop) since 1920, according to “How to Handle Stock Market Corrections.”
What’s more, market corrections tend to be short-lived. As the Forbes article “Investing Basics: What Is a Market Correction?” points out, the S&P 500 has taken an average of four months to return to its former high. The pandemic-related correction in March 2020 last three months, while the September 2020 correction lasted just three weeks. And the average decline before recovery? It’s 13.7%.
With all that said, it is impossible to predict when a correction will occur. Wall Street analysts and other knowledgeable folks can look at economic and market trends and say we are ripe for a correction. But they can’t know any more than you when one will actually occur.
We may not be able to tell you when the market will fall into correction territory, but we can provide some tips to help you ride out a correction.
Some Don’ts for a Market Correction
Don’t panic. We know panic is hard to avoid when a market is in a seeming freefall, but it’s essential to avoid reacting out of panic. Some of our dos that follow can help counteract the fear, as can the knowledge that markets correct regularly.
Don’t reassess your portfolio strategy during a correction. Your emotions are likely to be amplified at this time and can influence decision-making to your detriment. It’s better to wait until you can be objective about your investment strategy.
Don’t sell everything out of fear. Not only will you sell low (remember, the mantra is to buy low, sell high), but you’ll be on the sidelines when the market climbs again. You’ll have to buy at rising prices, so in effect, you lose twice.
Some Dos for a Market Correction
The best time to respond to a market correction is before it happens. The following two tips can help you prepare your finances and emotions so that you stay the course when the market drops.
Know your risk tolerance. Understanding how much risk you can stomach will help you stay strong when an index drops. As you approach retirement, you generally want to take on less risk so that market corrections (or worse) don’t wreak havoc on your nest egg. Consider talking with a fee-only financial advisor about the risk tolerance that aligns with your desired portfolio returns and financial goals.
Own a diversified portfolio. You can help achieve your risk and return needs with a diversified portfolio. An appropriately diversified portfolio can help insulate you from short-term market moves, like a correction, while working toward your longer-term goals. A diversified portfolio may include bonds, stocks, commodities, real estate, and so on. The stocks should be selected from multiple industries, company sizes, and countries (i.e., both domestic and international equities).
Once a market correction begins, you can:
Stay the course. If you own a diversified portfolio, you’re likely to see that when some equities drop, other assets hold their own or even gain. This can reduce any panic-selling you might be tempted to give in to.
Talk to your financial advisor. If you have an ongoing partnership with a fiduciary financial advisor, lean on them. They can serve as a coach, providing the voice of objectivity that helps get you through times like a correction.
Use extra cash to buy deals. When equity prices fall, you can buy some great deals. Look for quality companies that have strong fundamentals, and use cash that you earmarked for this purpose.
Just realize, however, that you may not be at the market bottom, which means the stocks you buy could end up dropping even further.
If that fact doesn’t sit well with you, then it may be better to consider a mutual fund or index fund that does the work for you. Alternatively, you can partner with a financial planner. We generally recommend a fee-only, fiduciary financial planner so that you get advice that is in your best interest, not the advisor’s.
Final Words
Market corrections happen, and the headlines about “record drops” can induce panic. But with some preparation, you can help ride out a market correction with confidence.
Our Greenwood Village, CO fiduciary financial advisory firm offers a complimentary 15-minute call. We can briefly discuss your financial situation and concerns, and share how we may be able to help.
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