Sorry to be the bearer of bad news, but another market correction is coming.
You may have heard rumblings on the topic, in fact we told our members last week exactly when we expect it to happen and areas of potential risk, focused on reducing exposure and increasing opportunity.
But before you phone a friend and jump into your car heading for the nearest cliff, there are a few things you should know…
Every time this happens we the same responses to being pre-warned about a coming correction:
- Does not believe it’s going to happen, does nothing
- Knows its coming but unsure what to do, does nothing
- Instantly starts taking action in line with their strategy, just right
- Immediately sells everything going up, sideways and down, does too much
Small or large movements in the market, up or down creates opportunity for those prepared for it. There’s nothing more boring than a stagnant market that sails sideways for months.
What is a correction?
Let’s start at the most obvious place, because truly understanding something helps you can shed your fear of it and it stops controlling your actions or inactions. Making you less likely to act on emotional decisions and stick to your plan.
A correction is a good thing (depending on your preparation).
While there is no official definition for this, a drop of 10% from market highs is generally considered a correction.
Given the inevitability of market pullbacks, it’s important to have an investment plan you can stick with through market ups and downs. Active investors should think about exit strategies during market volatility.
The sell-off could be driven by concerns that earnings growth, while strong, may be peaking and that economic growth has been slowing in the U.S, China and other parts of the world.
So with a correction around the corner, it may be time to brush up on what corrections have typically looked like, and what action you want to take to protect yourself.
How long and deep will this correction be?
No one can predict the timing or depth of a stock market correction with certainty.
What we do know is that they have historically been a standard part of investing. In fact, since 1920, the S&P 500 has on average experienced:
- 5% pullback 3 times a year
- 10% correction once a year
- 20% bear market decline every 3 years
While it may be unsettling, it’s not unusual to experience a sell-off of this magnitude.
Stock market corrections happen regularly
One thing that is worth remembering is that the market typically recovers pretty quickly from correction.
The chart below shows the largest drop from a market high in each year (blue dot). You can see that it’s not uncommon to have significant market declines. But the market still usually recovers and produces positive results for the year (shown as the bars).
S&P 500® Index annual total returns and intra-year declines: 1980–2018
What does it mean for investors?
There’s a phrase that outlines this perfectly – Amat Victoria Curam, otherwise known as Victory Loves Preparation.
A market corrections level of impact on your portfolio is directly related to your level preparation for it. Everybody trades differently but so much the same as well…
1. Long-term investors: Stick to your plan
If you are saving for retirement or another goal that is years away, the time to consider how much of a loss you can handle isn’t during a correction. Consider the appropriate risk level for your portfolio when you are looking at your long-term goals, and think clearly about your financial situation and emotional reaction to risk.
If you haven’t created a plan, you should.
If you have a plan, it’s worth checking in that your investments are still in line with that plan. And does it continue to reflect your investment horizon, financial situation, and risk tolerance. If all that is so, you will likely be in a better position to manage the ups and downs of the market. If your mix of investments is off track, consider rebalancing back to a more neutral positioning.
2. Active investors: Be ready
While most investors who have a long-term plan probably don’t need to make any portfolio changes in anticipation of a spike in market volatility. Some more-active investors may want to take action to prepare for more volatility. That could mean setting exit strategies on current positions, using stop loss orders, or tracking technical indicators for signs it’s time to sell.
More active investors might also want to consider having a cash reserve, and creating a watch list of stocks to consider buying at certain price points, to prepare for buying stocks during the downturn.
3. Retirees: Manage your income
For retirees, who may be relying on their investment portfolio for a portion of their income, a market drop can present a different kind of challenge. Hopefully, retirees have an income plan that is built to withstand different market conditions. If so, you really won’t need to react to a short-term market move. If not, it may be a good time to sit down with an advisor to discuss you strategy.
The bottom line
Market corrections are inevitable, like death and taxes.
While we don’t know if this will be short-lived or the beginning of a bigger downturn. History shows that the market recovers quickly from corrections, and most sound investment strategies are built to withstand volatility.
As a result, long-term investors should stick with their plan, and not take on any hidden risk.
So turn off the engine and drive away from the cliff, now is not the time! Want the inside track on this?
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