How to Weather a Stock Market Correction
Investment prices rise and fall, sometimes by significant amounts at a stretch. A sustained increase in prices is called a bull market. A sustained drop of 10% to 20% is called a correction; a sustained drop of more than 20%, a bear market. All three conditions are facts of market life.
In the stock market, periods of sustained increase and periods of sustained decline have tended to alternate over time. What's more, as a general rule, the periods of increase have tended to outweigh the periods of decline. As a result, equities generally appear to have had the strongest average performance of any investment class over the long run, although past performance is no guarantee of future results.1
If it were merely a matter of arithmetic, it could be relatively simple for an investor to wait out a market dip for the next recovery. But how investors feel about their portfolios can be just as important. Price dips tend to stoke investors' fears. So, when stock prices begin falling, many investors tend to act quickly and make poor decisions, adversely affecting their financial condition.
On the other hand, investors who have taken steps to prepare their portfolios for occasional market drops generally are better able to manage their emotions when stock prices head south. They could make thoughtful changes but only where there would be solid rationales to support them.
Sizing Up Your Portfolio
While the best portfolio design anticipates all possibilities from the outset, you can improve your planning at any time. So, if confronted with an unanticipated market condition, take time to review your portfolio. Are all your investments in stocks or stock mutual funds? Do you own just one stock mutual fund? Have you invested in only a few high-flying stocks?
Remember, all investments involve risk. As a long-term investor, you should not focus on short-term volatility. But you can also make the long journey a little more enjoyable by taking a few steps during a market correction. Here's a short list of some risks you may face as a holder of stocks or stock mutual funds and some ideas about how to potentially reduce the chances that your portfolio suffers a big loss.
A Healthy Market Decline
It's important to remember that periods of falling prices are a natural and healthy part of investing in the stock market. Investors who are concerned about this risk can consider strategies to help them limit their overall investment risk position.
One risk that some investors may be exposed to is the risk of falling short of reaching a long-term financial goal. Investing too conservatively may contribute to not reaching an accumulation target. Remember that despite several down cycles, stock prices have historically risen over longer time periods. (Past performance, however, does not guarantee future results.)
1Source: SS&C Technologies, Inc. Based on total returns since 1926 of stocks, represented by the S&P 500 Index, bonds, represented by the Bloonberg Barclay's Aggregate Bond Index, and cash, represented by rates on short-term Treasury bills. Past performance is not a guarantee of future results. Index results do not account for the impacts of taxes or investment expenses. It is not possible to invest directly in any index.
2An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although most funds seek to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in a money market fund.
Evaluating Investment Risk - Article