Market Corrections

How to Learn to Stop Worrying and Love a Market Correction

 
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The last time the market dropped double digits, numerous Republican candidates were lining up for president, tech fanatics awaited the arrival of Apple’s newest offering, and the world celebrated a joyful event in the lives of the British Monarchy.

Sounds like what came across your Twitter feed or what you read in the newspaper over breakfast this morning? Believe it or not, those events all happened back in 2011.

April to October of 2011 was the last period that the U.S. stock market experienced a market correction—a drop in the market of more than 10 percent but less than 20 percent.1 Four years ago is not ancient history by any means. But the length of time that has passed between the last market correction and now is atypical.

The market has been riding high for the past 44 months,2 now the third longest stretch without a correction since the S&P 500 Index was first introduced in 1957.3 Historically, a correction occurs on average of every 2.1 years.4

Propelled by the Fed’s continuing efforts to keep interest rates low, stocks have been the go-to option where investors found sizable returns over the past few years. However, experts say that winning streak will eventually come to an end, at least temporarily. That could be good news for long-term investors— if you stay calm and have a plan.

A Correction Isn’t a Crash

A market correction is just what the name implies—a correction to a market that has shot too high in valuation. The drop may seem a bit frightening at first. With 2008 still fresh in investors’ minds, it’s understandable why most of us would feel a tinge of apprehension. But don’t panic.

A correction is a natural part of the life cycle of the market. It doesn’t necessarily indicate that the market will nose dive into 2009 territory of 50% market losses. If losses begin to creep above 20%, we’re no longer in a correction; we’re entering a bear market. The best way to evaluate your stance is by discussing your options with your advisor before a correction takes place.

Develop and Stick to a Sensible Plan

Timing the market is not advisable. But that doesn’t stop many investors from shifting their investments into cash in the hopes of avoiding market downturns. Consequently, they often miss the market’s best returns. Rather than trying to time the market, investors should focus on time in the market, allowing investment returns to compound year after year.

Selling off stocks after they dip during a correction may leave you worse off than you would be if you remained invested. Don’t sell just because others are selling. Instead of the significant volatility shown by quarterly returns, the market appears comparatively tranquil over a longer time period—an insight that may be forgotten amidst short-term market swings. Long-term buy-and-hold investing may not be exciting, but it has historically been an effective strategy.

Be Greedy When Others are Fearful

"The more [the market] goes down, the more I like to buy," said Warren Buffett on CNBC as he bought stocks during a selloff last fall.5 Consider taking advantage of a correction and turn the risk of volatility into a great opportunity buy at a discount if this strategy fits in with your time horizon and risk profile. Picking up stocks at a lower price can be a great way for investors to gain new investment opportunities with greater growth potential.

Discuss with your financial advisor ahead of time which buying strategy would best fit into your long-term plans before the signs of a correction begin to show themselves. Talk to your financial advisor to see what is most suitable for you.

Figure 1

Two Hypothetical Approaches to Volatility: Growth of $10,000 Invested in S&P 500 Index (12/31/74–12/31/14)

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Data Source: Thomson Reuters, 2/15

*T-Bills are guaranteed as to the timely payment of principal and interest by the U.S. Government and generally have lower riskand-return than bonds and equity. Equity investments are subject to market volatility and have greater risk than T-Bills and other cash investments. 

Index past performance is not indicative of future results. For illustrative purposes only. The performance shown is index performance and is not indicative of any investment. Investors cannot invest directly in an index.

Above are the effects of two different historical approaches to volatility. Each assumes $10,000 invested on 12/31/74 into the S&P 500 Index and no taxes or transaction costs. The opportunistic investor added $2,000 each time the market dropped 8% or more in a month, and the apprehensive investor shifted assets in the face of volatility. Ultimately, the opportunistic investor had a return that was more than twice as high at the end.

Failing to Plan Is Planning to Fail

Speak with your advisor to better understand how you can position yourself now for what’s likely to come when the next correction occurs—whether it’s next month, next year, or several years from now. The market’s cyclical nature is a fundamental truth investors need to keep in mind, and a diversified portfolio consisting of a broad assortment of investments is intended for just such an occasion.


1. Source: “The Stock Market Correction That Nobody Noticed,” Money, www.time.com/money, July 8, 2014
2. Source: “An Investment Lifeboat Drill Now Can Help Weather Future Disaster,” New York Times, May 18, 2015
3. Source: “Bad Breadth Portends Stock Market Correction” June 9, 2015
4. Source: “What To Do When The Stock Market Drops 1800 Points,” Forbes, June 4, 2015
5. Source: “Warren Buffett: I Bought Stocks in Wednesday’s Big Selloff,” CNBC, Oct. 2, 2014

All investments are subject to risks, including the possible loss of principal. Diversification does not ensure a profit or protect against a loss.

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