At the start of the covid-19 pandemic, we experienced one of the deepest and fastest corrections in history (some might call it a crash, but both terms would be correct). the s&p 500 lost 30% in a matter of weeks, then made a full recovery in five months.
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the covid correction offers a key lesson: when stocks go through a correction, avoid overcorrecting. panic moves only ensure losses and lose future profits. just over 12 months after the bottom of the correction, the s&p 500 had doubled in value. investors who hedged likely missed out on some or even all of those gains.
During the heat of a correction, it can be almost impossible to stay cool and collected. Here’s a guide to keeping your sanity and money during a stock market correction, when it seems everyone around you is losing theirs.
what is a stock market correction?
A stock market correction is a broad decline in major market indices from 10% to 20%, although there is no formal definition for the term. corrections are inevitable facts of life for investors. in fact, one occurs on average once every two years.
It is called a correction because stock market declines tend to “correct” the market after a period of irrational exuberance, returning prices to their long-term trend. Sometimes corrections turn into a bear market, when market indices are down 20% or more. but the vast majority of corrections have not turned into bear markets.
how long do market corrections last?
data from yardeni research shows that since 1950, there have been 39 corrections of the s&p 500 index, including the current ongoing correction. that’s an average of one correction every 1.9 years.
Only seven of those fixes have taken more than a year to resolve. meanwhile, 24 of them lasted three and a half months or less. In total, the S&P 500 spent 7,168 days correcting from high to low in the 38 corrections prior to the current one. that means the average correction lasted 189 days, or about six months.
the first rule of corrections: take perspective!
It’s normal to be nervous when a stock market correction hits. but the first rule of thumb during any correction is to get some perspective on what’s going on.
During the dark days of the Great Recession of 2007-2009, investors lost more than half of their money when the housing bubble burst and global markets crashed. Outside of a global pandemic, it’s hard to imagine a more terrifying time for markets.
Investors who bore the brunt of the Great Recession had to be patient to get their money back, but if they stuck it out, they got it back. The S&P 500 bottomed out in a recession in early 2009. In early 2013, the index hit record highs again.
avoid the news, don’t talk about stocks with friends
I hate to say it, but news shows that follow the markets minute by minute aren’t very helpful when it comes to maintaining perspective. How much you lost or gained today will never inform sound decision-making, warns Liz Weston, author of financial books like Dealing With Your Debt.
“Once a correction occurs, limit your exposure to news about it and avoid checking your balances,” Weston says. “Fear can trigger impulsive reactions, like selling during a recession and insuring your losses.” remember: if you haven’t sold it, you haven’t lost it.
This coping strategy may also mean you also want to avoid hanging out with market-obsessed friends. this is a good time to take a break from the constant talk about wall street.
when a market correction heats up, stay cool
You have spent a lot of time making a financial plan. you’ve read the blogs, maybe worked with a professional, and made the best decisions you could. now is the time to be confident in your strategy and stick with it. don’t change direction just because there’s a correction coming your way.
Behavioral scientists talk about hot and cold cognition. cold cognition involves formulating ideas and making rational decisions based on facts. but when we’re agitated, warm cognition kicks in and our emotions rule the day.
A trick to succeeding in a correction is to recognize when you enter a state of warm cognition. That’s the moment when you need to stop acting and trust the decisions you made when you were cold.
consider making minor adjustments during a fix
There’s no reason you can’t re-evaluate your previous options based on new information during a stock market correction. Maybe you really believed in tech stocks five years ago when you built your portfolio, but now you’re starting to think they’re too risky or that government regulators are about to change the earnings equation for the industry.
Never let a crisis go to waste, and a market downturn could be an occasion to reexamine and adjust your plans. that’s cold ideation in action, and it’s quite different from an emotional impulse to sell because of a bad day in the stock market.
corrections may be a good time to review your overall investment strategy and consider rebalancing your portfolio. perhaps one investment held up well while the others fell, and is now an outsized part of your portfolio.
just don’t make your move at 3:45 p.m. m. et after seeing another market sell-off in the late afternoon. Sketch out a new plan with pencil and paper on a Saturday morning at your local coffee shop.
Your Correction Superpower: Dollar Cost Averaging
Watching the markets fall day after day can get into your head, but don’t let it. Most importantly, don’t be tempted to sit on the sidelines with your available cash. The thing about stock market corrections is that you never know when they might turn, and studies show that missing out on a big market turn can kill your portfolio.
J.P Morgan research reveals that investors who missed the top 10 trading days over a recent 20-year period would have seen their returns cut nearly in half, compared to those who stayed invested the entire time . when did those top 10 days occur? often after some of the worst trading days, in the depths of a correction.
never try to time the markets; This advice cannot be repeated often enough. that also means it’s impossible to calculate the point at which a stock market correction might turn around. All of this makes dollar cost averaging your best friend during a market correction, even if you’ve already implemented the strategy with regular contributions to a workplace 401(k) plan.
“if you have dollar cost averaging in a retirement plan or other account, continue; buying in a recession essentially means you’re buying stocks on sale,” says weston.
about to retire? don’t be scared.
Market corrections should not alarm long-term investors decades from retirement. after all, you’ll have forgotten about the recession when you need the money you’re saving in your retirement plan.
But investors nearing retirement may have something to worry about. workers who planned to retire in 2008 or 2009 really had bad luck. or was it luck? trying to squeeze every last dollar out of investments just before you need the money (to retire, buy a house, pay for college) is a losing proposition.
Ideally, future retirees should plan for their cash needs years in advance. they should slowly trade risky investments for safe investments when it makes sense, well before retirement. If this describes your retirement planning process, don’t let the correction derail you.
Like balancing your portfolio, a stock market correction might be the right time to reevaluate your retirement plan. Hanging up your spurs during a market correction or bear market is a risky choice. maybe you should consider working a few more years, rather than plunge into full retirement. the longer your investments remain in the market, the more time the compounding has to work its magic.
Maybe all of this sounds good to you, but you’re still losing money! right now! look at all that red! At a time like this, it’s hard to resist the urge to do something.
Take that energy and put it into researching your next five or ten years. what has happened has already happened. you cannot correct a market error after the fact; it is a sunk cost.
now is the time to take all that regret and turn it into something useful. don’t over-correct by pulling the trigger on trades inspired by today’s bad news. if she is 35, talk to you who is 45 and make a plan for her. make an appointment to speak with a financial advisor. Read some investment books and gobble up as many resources as you can.
The goal is to avoid having to regret it the next time a correction arrives. because even when this one is ending, the clock is already ticking for the next one.