Reading Time: 4 minutes
Stocks went into free fall on Monday, February 5, 2018, and the Dow plunged almost 1,600 points easily the biggest point decline in history during a trading day. The drop amounted to 4.6% the biggest decline since August 2011, during the European debt crisis. But it was nowhere close to the destruction on Black Monday in 1987 or the financial crisis of 2008. Still, for investors lulled to sleep by the steady upward climb since Election Day, it was a wake up call. With markets in the second longest bull market in history, a pullback or correction almost seems foreign. According to Wharton School finance professor, Jeremy, Siegel, “The recent market pullback doesn’t signal a bear market, but possibly a correction coming that will chase out the speculators.”
What is a Correction?
A correction is a decline or downward movement of a stock, a bond, a commodity or market index. The amount of the decline is at least 10 percent but not more than 20 percent. In short, corrections are price declines that stop an upward trend.
When the stock market starts tumbling — especially when it’s down more than 10% — many people panic and start to sell. They’re scared the slide could turn into a death spiral. Maybe they are being prudent and sensible. No, often, they are being irrational.
If you panic and move into cash during a correction, you may well be doing so right before the market rebounds. Once you understand that the vast majority of corrections aren’t that bad, it’s easier to keep calm and resist the temptation to hit the eject button at the first sign of turbulence.
Let’s all take a deep breath. As many commentators have noted, this market was overdue a correction, which is much healthier than continued parabolic increases in share prices. How much inflation are we really talking about? And by how much will new Fed Chairman Jerome Powell really raise rates? Has anything in the global economy fundamentally changed from a week ago?
A stock market correction isn’t necessarily a bad thing depending on the context you view the correction from. However, there are five important things you really should know about a stock market correction.
1. Stock market corrections happen often
The first thing you should know is that stock market corrections happen fairly often. The U.S. economy naturally peaks and troughs over time, and in response the stock market will also have its peaks and troughs. On average, there’s been a market correction every year since 1900. The S&P 500 has gone without a correction for about two years, an unusually long gap.On average, there’s been a market correction every year since 1900. Click To Tweet
Long story short, corrections are an inevitable part of stock ownership, and there’s nothing you can do as an individual investor to stop a correction from occurring.
2. Stock market corrections rarely last long
Corrections last for a shorter period of time than bull markets. Stock market corrections often tend to be on the order of a few weeks to two quarters in length.
3. Stock market corrections shouldn’t matter if you’re a long-term investor
If you remain focused on the long-term with retirement as your goal, then you’ll realize that stock market corrections really aren’t an issue The only people who should be worried when corrections roll around are those who’ve geared their trading around the short-term, or those who’ve heavily leveraged their account with the use of margin. Maintaining a long-term perspective has been the smartest way to invest throughout history – and it also happens to be a recipe for a good night’s sleep.
4. They’re also a good reminder to reassess and rebalance
It’s important that you reassess your holdings to ensure that the thesis of your purchase remains intact. Ask yourself one simple question with each stock in your portfolio: Is the reason I bought this stock still valid today? If the answer is “yes,” then no action is required, other than perhaps adding to your position. If your thesis is no longer intact, then it may be time to consider selling your position.
Rebalancing is another way to reduce risk in your portfolio. As US equities have had a strong run recently, they may be dominating the overall portfolio. By rebalancing back to pre-determined portfolio weights, the risk may be reduced, allowing you greater chances of achieving your goals.
5. Nobody can predict the future.
Unfortunately, know one knows what the future holds. It is important to have a long time horizon and accountability advisor who can be your behavioral coach, especially as market volatility may likely increase. At Intelligent Investing, we strive to align our clients’ portfolio with their financial plan, keeping in mind their ability to take on risk and their willingness to take on risk. As risk managers, we monitor portfolios and are alerted when portfolios breach a predetermined risk tolerance band. If you’d like to learn more about how we may help you manage your wealth to achieve your goals, please click here. We look forward to the opportunity of serving you soon.
Bonus: Here are the past 10 corrections in the S&P 500 index.
|Span of the correction
|Decline in Percent
|May 21, 2015-Feb. 11, 2016
|April 29, 2011-Oct. 3, 2011
|April 23, 2010-July 2, 2010
|Nov. 27, 2002-March 11, 2003
|July 16, 1999-Oct. 15, 1999
|July 17, 1998-Aug. 31, 1998
|Oct. 7, 1997-Oct. 27, 1997
|Oct. 9, 1989-Jan. 20, 1990
|Oct. 10, 1983-July 24, 1984
|Feb. 13, 1980-March 27, 1980
|Oct. 5, 1979-Nov. 7, 1979