Worried About the Next Market Correction? Here’s What to Do
What goes up must come down. With the stock market trading at record highs, financial analysts are forecasting a crash. When that drop occurs, no one knows. But here’s what you can do to help protect your portfolio (and nerves!) when the next correction happens.
Stock Market Corrections Happen Regularly
Corrections—defined as a 10% or more drop in a market index—often occur in response to an event that prompts investors to dump their stocks. The COVID-19 pandemic was such an event, causing a market correction in March 2020.
In our experience as financial advisors, each correction feels like new territory for investors. It’s as though many investors forget the previous corrections they survived, and they panic. Yet market corrections occur regularly. If you look at the S&P 500’s history, you’ll see it has experienced 54 market corrections and bear markets (a decline of 20% or more) since 1920.
What’s more, corrections tend to be short-lived. It took just three months for the S&P 500 to recover from the pandemic-related crash in early 2020. In September of the same year, we experienced another market correction, and that one lasted just three weeks.
These time frames aren’t anomalies. As the Forbes article “Investing Basics: What Is a Market Correction?” states, the S&P 500 has taken an average of four months to rebound from a correction.
That said, corrections can and do last longer than four months, and if we experience a bear market, the average recovery takes 14.5 months.
How to Prepare for a Market Correction
Our Roseville-based fiduciary wealth management firm likes to say that the best way to deal with a market correction is before it happens. If you wait until a correction, you’re too late. You may end up making decisions in a panic that hurt your finances and goals.
Here are tips to help prepare:
Own a diversified portfolio. With a diversified portfolio, you help protect your finances against short-term market moves like a correction while building toward long-term goals like retirement. You own a variety of assets, such as bonds, stocks, commodities, and real estate. Your stocks also come from a variety of countries, market capitalizations, and industries (not just technology, for example).
You might resist owning a diversified portfolio as part of your investment strategy, preferring to put your cash toward the stocks with the highest returns. However, those winners could easily become tomorrow’s losers (dot-com crash, anyone?). With a diversified portfolio, when one portion of your portfolio falls, another part can hold its own or even increase in value.
Know your risk tolerance. You’ll seek a certain return on your portfolio to achieve your long-term goals. That return should be balanced with your stomach for market risk, or risk tolerance.
By understanding how much risk you can tolerate, you can structure your asset allocation to reflect that tolerance. For example, earlier in your career, you have a longer timeline to achieve your financial goals, so you may be willing to accept higher risk—such as a portfolio with 70% equities and 30% fixed income.
Later, as you approach retirement, you want to reduce the market’s ability to wreak havoc on your investment returns. So you likely adjust your allocation ratio so that you own fewer stocks and more bonds.
The right risk tolerance can help you withstand times of volatility. If you find yourself panicking in a market correction, you may want to reassess the risk you find acceptable. (Don’t do this reassessment when your feelings are running high—wait until you are more objective.)
We recommend investors reassess their risk tolerance regularly to make sure their portfolio is aligned with their age, life stage, return needs, and longer-term goals.
And what happens when there is a market correction? First, take a deep breath. Know that with an appropriately diversified portfolio, you have helped insulate your finances from this shorter-term volatility.
Many investors get fearful and sell off losing stocks. But if you do that, you disregard the objective of “buying low and selling high.” You’ll also be on the sidelines when the market recovers.
If you have cash on hand, you can buy some deals in a market correction. Look for high-quality companies with strong fundamentals, and only use cash that you have freely available—not money that is earmarked for retirement account contributions, savings, or bills such as your mortgage.
But realize that you may not be buying at the market bottom and that stocks could decline even further. A market bottom is as impossible to predict as a market correction. If that fact doesn’t sit well with you, you may want to consider a mutual fund or index fund that does the work for you.
Or you may decide to work with a financial advisor. They can manage your portfolio for you so you can put your focus on other areas of your life. And they can also serve as an objective coach to help you negotiate the fear that market corrections tend to cause.
We generally recommend a fiduciary, fee-only financial advisor so that you can be sure that their advice puts your interests first.
Schedule a complimentary, 15-minute call with a fee-only, fiduciary financial advisor today to discuss your personal situation.
This material was prepared by Kaleido Inc. from information derived from sources believed to be accurate. This information should not be construed as investment, tax or legal advice.
Parkshore Wealth Management is a family-owned, independent, fee-only Registered Investment Advisor serving the greater Sacramento area with an office in Roseville, CA. We partner with financially responsible individuals and families who are eager to take positive steps that will allow them to use their money to build the life they desire. The firm is led by Harold Anderson, CFP®, and Daniel Andersen, CFP®, both members of NAPFA, the country’s leading professional association of fee-only financial advisors.