“The stock market is the story of cycles and of the human behavior that is responsible for overreactions in both directions.” – Seth Klarman
One of the more unnerving parts of being an investor is experiencing the market pullback or market correction. Watching your investments fall by 10% (or more) is undeniably stressful, but the truth is: these events are as cyclical as the market itself, as long as there’s a stock market, there are going to be corrections. So, what can you do about it?
Humans hate losing more than they love winning, and for this reason, mistakes are often made when the market starts to dip. Just because market corrections are cyclical, doesn’t mean they’re predictable. Trying to time the market won’t work either, it’s impossible to know how long these things will last, how far the market will drop, or how quickly it will recover.
According to a table created by Merrill, timing the market could prove to be more damaging than holding, aka not touching your investments at all. Merrill evaluated the growth of $1,000 to see what happens when you leave an investment untouched over a 20-year period (Row 1); when you pull it out during the top 10 performing months (Row 2); and when you pull it out during the top 20 performing months (Row 3).
The Risk of Missing Out
| Miss 10 top-performing months||$7,000||$1,380||$1,723|
| Miss 20 top-performing months||$3,363||$722||$1,097|
As you can see from the chart above the best overall strategy is leaving your $1,000 investment untouched for as many years as possible.
The fact of the matter is that the longer you’re investing in the market, the more likely you’ll experience a drop. The question is: how will the market correction affect you? Well, there are three different potential outcomes: 1.) You’re negatively impacted by it, 2.) There is no lasting impact on your portfolio, 3.) You actually benefit from the market correction. The outcome is largely up to you, but I’m guessing you’d like it to be outcome three and would at least accept outcome two.
Let’s go over the ways to prepare for, and take advantage of, a market correction so the next time one comes around you’ll be able to benefit from it.
Best Practice #1: Reduce Panic, Increase Planning
As with everything in life, making rash decisions while panicking leads to mistakes. Unfortunately, after decades of watching negative headlines create market volatility, combined with the increasingly hysteric nature of modern-day journalism, it can be tough not to live in a perpetual state of panic these days. You should not allow this panic to translate into how you do your financial planning. Do not make rash decisions in place of planned decisions.
To reduce panic, you must equip yourself with information. Luckily, there are plenty of cases analyzing years of data which can help investors gain perspective on market corrections. For example, when looking at post-World War II market declines, you can see that an overwhelming majority of dips occur in the 5-10% range and take about a month to recover from. This means that if you’re experiencing a dip in your portfolio, there is a non-negligible chance that you’ll recover your losses in a month or so.
Additionally, any decline between 5-20% also only takes a few months to recover from, while a decline between 20-40% takes a little over a year to recover from—this data demonstrates that patience is your friend when it comes to the market.
|%||#||Avg %||Avg Length (Mo.)||Avg Recover Time (Mo.)|
Obviously, all this data is gathered retrospectively after there’s been time to digest the decline but still, these figures provide a powerful perspective and encouragement. There’s no need to panic when you hear rumors of a market correction looming.
Best Practice #2: Diversify Your Portfolio
It’s not a question of if a market correction is coming, the question is when. Having cash in hand and a list of stocks you’ve been wanting to buy can turn a stressful time into an exciting one. A market correction is the perfect time to diversify your portfolio and an opportunity to buy in at lower rates. Think of it as a sale.
There are a few things to consider while you’re reevaluating your portfolio:
- Consider your stock/bond mix. It’s always good to have a mix of cash, equity, and fixed income. The amount you have invested in each category largely depends on where you are in life, as well as your long-term/short-term financial goals. Market fluctuations shouldn’t cause you to move all your money into bonds just to avoid risk, but should instead be used as an opportunity to see if the reason you purchased certain stocks are valid in regards to your lifestyle.
- Reevaluate your stock allocation. Using the cyclical nature of the stock market to your advantage can help you research which sectors you’d like to move into, and which ones are no longer useful to your financial goals. Overall, it’s best to broadly diversify your stocks, but with so many sectors to choose from, it can be hard to figure out where to invest. Using a market pullback to invest in some exciting sectors can help you take full advantage of the recovery.
Checking in with your portfolio during a market correction is the best way to prepare to make smart money moves when the market recovers.
Best Practice #3: Work with a trusted advisor
Having someone in your corner with an unbiased view will help immensely when it comes to harnessing market corrections to your advantage. Our team has loads of experience with market corrections and is less likely to be emotionally triggered by the twists and turns of the market. Plus, with more than 250 years of combined experience, our team can help separate panic and emotion from financial decisions.
Your financial advisor will also be able to review both short-term and long-term goals, to give you options which complement your risk tolerance. They will provide you with a roadmap to help you from getting lost during turbulent times in the market.
Our firm has more than 30 years of experience in helping clients. I’ve seen every kind of market and every kind of reaction to it. There have been dozens of events in the past year that have been deemed “unprecedented” and scared people into thinking things were “different this time.” While I don’t want to downplay the tumultuousness of these times, I do want to reassure you that just because things feel unnaturally difficult, doesn’t mean that we can’t base our actions on what has worked in the past. The events may be different, but they always yield the same cause and effect.
I have experienced, first hand, almost 35 years of enormous societal changes, both amazing and horrendous. Even though the cyclical market is hard to pin down, and impossible to time, the fundamental financial decisions that add up to sound investments are not. Our team is here for you, along with our decades of experience, to help make sense of what’s the best financial plan for your personal vision.
Randy Carver, CRPC®, CDFA®, is the president and founder of Carver Financial Services, Inc., and is also a registered principal with Raymond James Financial Services, Inc. Randy has more than 32 years of experience in the financial services business. Carver Financial Services, Inc. was established in 1990 and is one of the largest independent financial services offices in the country, managing $2.2 billion in assets for clients globally, as of August 2021. Randy and his team, work with individuals who are in financial transition as a result of divorce, retirement, or the sale of a business. You may reach Randy at email@example.com.
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