Market Corrections in Perspective

With recent volatility in the stock market, it’s not uncommon to feel uneasy about your investments. So what should you do?

What to do When Stock Markets are Tumbling 📉

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What is a market correction?
A stock market correction by definition is a decline of 10% in a given market index from a recent high value. A bear market is the same concept, but a decline of more than 20%. Per the chart below, market corrections typically happen on average every 1.6 years and it’s a perfectly normal, healthy part of a market cycle.

The price of a given stock (and by extension a large collection of stocks like the S&P 500 or Dow Jones Industrial Average) is based on a variety of different factors. The underlying assets & liabilities of a business and how profitable the company is provide insight, but a major influence on a stock’s price is actually how it’s expected to perform in the future. Since we can’t jump in a DeLorean and visit the future, the price of a stock today is partly based on how things that are happening today will impact that stock in the future. As a result, there are thousands of reasons why a company might do better or worse from things happening today, based on how those events impact the company over the long term! Regulatory changes, economic numbers, interest rate fluctuations, improved or reduced earnings, new products, trade agreements, consumer sentiments, and even global pandemics. These are just a few of the things that could happen in the present to impact the future earnings of a company.

Since stocks trade partly on expectations of future earnings, it’s possible that events or circumstances may change as time goes on which alter previously held expectations for how a stock or market index would perform. If a new, unforeseen strain of Covid comes along that is likely to reduce the revenue that businesses are able to earn in the future, stock prices may decline as a reflection of those expectations of lower future earnings. If the event is big enough (like in February 2020 above when Covid first came on the scene), markets may sometimes decline as much as 10% or 20% in a short period of time. Sometimes even more.

This sort of things happens all the time
Per the chart above, a 10% decline in the stock market happens on average once every 1.6 years. The last time this happened was in March 2020 when the entire world was in a panic over what unknown implications the coronavirus would have on public health and economies around the world. In short, we were about due for something like this to happen.

1. Are market corrections a bad thing?
Yes and no. In the short term, market corrections can be difficult for investors to stomach due simply to the fact that it’s not enjoyable watching your investment portfolio decrease in value. However, it’s times like these that can be really defining for the long-term success of an investor’s portfolio. Being invested for a reason (retiring, buying a house, paying for college, etc.) and remembering what that reason is can be really powerful in providing perspective on the importance of staying invested through difficult times.

2. Can market corrections and bear markets be predicted?
Unfortunately, no. Since it’s not possible to look into the future, there really isn’t a way of knowing when exactly a market correction may occur. Instead, it’s better to be prepared for when they occur, both mentally and in the construction of your portfolio, to ensure you’re able to successfully weather the storm.

3. So what should I do during a market correction?
The answer to this question is going to vary from individual to individual, but by and large the answer is simply….nothing! Selling all of your investments and ‘moving to cash’ typically doesn’t work because there’s no way to know when to reinvest those funds. Investors who employ this strategy often miss out on a lot of the upside when a market recovers. There may be buying opportunities during a market correction as many stocks have decreased in value, but trying to time a market bottom is also nearly impossible. The key to successfully navigating a market correction is ensuring that your portfolio is properly constructed prior to the correction even happening and just as importantly, making sure you’re keeping the long term in mind when taking action (or inaction) today.

Cheer Up!
Corrections in the stock market and market volatility in general can create a feeling like something needs to be done or an action needs to be taken. Should I sell a few of my ‘losers’? Holy cow I’m down 10%, shouldn’t I sell before it decreases 20%?! How will I ever retire if my portfolio keeps declining?! Each of these questions is valid in their own right, but possibly the most important thing to remember in situations like this moving forward is to have a financial plan that’s built custom to your situation. With a properly prepared financial plan and properly constructed portfolio to support it, market corrections don’t have to be cause for major concern.If you’re feeling like you’re finances aren’t aligned with your financial goals or what’s important in your life, consider scheduling some time with us for no-obligation consultation. Finally, if the above wasn’t helpful enough to cope with volatility in the market, here are a few points that may help put things in perspective.

If you look at stock market data from 1926-2015, on average if you invested money in the market over a 12 month period, you had a 74% chance that you’d have a positive return.*

From 1920 to 2020, the worst total overall stock market return over a given 20 year period was 54%, but if that timeframe was extended to 30 years the total return was 854%.*

If all else fails, focus on the fact that you’re planning for the long term and find things to distract you from short-term market volatility! 🧘🏻‍♂️📘🍷

*https://awealthofcommonsense.com/2015/11/playing-the-probabilities/

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