It’s a terrible feeling. You open your investing app and see that the value of your portfolio is down again. Has something gone wrong?
Stock market cycles have four phases: bull markets, bear markets, accumulation, and distribution. It’s a bit like the circle of life. Sometimes the good times take a breather.
What’s a market correction?
A market correction is when a stock, index, or sector falls in price by between more than 10% and 20% from its most recent peak.
And it can actually be pretty healthy if you take a long term view – which we do at Spaceship. Valuations can become more realistic, and high-value stocks are discounted and can present buying opportunities.
But it still feels pretty bad to see your hard-earned money worth less than when you started. It’s not what you started investing for.
How long do market corrections last?
Luckily, market corrections don’t last forever. Nobody can ever predict market movements, but history can calm the nerves.
CNBC and Goldman Sachs reported that corrections in the S&P 500 – which tracks the performance of the 500 largest companies in the United States stock exchanges – historically have tended to last for four months on average, before taking roughly the same amount of time to regain their highs. Some of them do last longer – and if prices fall more than 20% it can become a ‘bear market’ which may take longer to recover.
What causes a correction?
Market corrections can be caused by many different reasons. These can include a slowing economy, higher interest rates, ‘unprecedented times’ such as a pandemic, or general fear.
Should you panic?
One thing that’s common to market corrections is that some people panic and lock in their losses.
As we’ve mentioned before, panic selling is a terrible strategy. When you panic sell, you’re removing the chance for your investment to recover in value. If you panic sell your investments at a low, it could lead you with less of an inclination to try investing again – potentially missing out on future gains in better conditions. And of course – when you panic sell, you forget that volatility is to be expected and markets do, historically, tend to rise in the longer term.
Fun fact: MIT research revealed that those most likely to panic sell are men over 45, married with children who have ‘self-described excellent investment experience’.
But not all selling is panic selling. There are legitimate reasons to sell, too. Some reasons can include your investment underperforming the market, that you’ve lost faith in its management or strategies, or that you need the money soon and you think it’s going to get much worse.
How do you know if a correction will get worse?
There are never any guarantees when investing. The start, end, depth and recovery of a correction are unpredictable – it’s just how it goes. There were 17 corrections in the S&P 500 between 1980 and 2020 – and each time, the market rebounded – though six of the 17 did first become bear markets.
Bear markets are represented by a drop of 20% or more from a recent high. We’ve previously written about the differences between corrections and bear markets.
What do the pros do?
Professional long-term investors understand that corrections are a normal part of investing. Some keep diversified portfolios to minimise their exposure to volatility. A diversified portfolio means that your investments are spread across different assets or industries. It helps minimise your risk because different asset classes and industries perform differently at different times. You can read more about the relationship between risk and diversification here.
Some professional investors see corrections as sales opportunities. The companies that they already liked become available at discounted prices. At Spaceship we take a long term view to investing. Our Spaceship Universe and Spaceship Earth portfolios are filled with companies we think adhere to our investment ethos of Where the World is Going. It means that when we pick stocks – we’re backing them for the long term, though we will sell if something happens that changes our view of their long-term success. So when they go on sale during a correction, we get excited to pick them up at cheaper prices.
Warren Buffett has the analogy of Mr Market.
Suppose your next door neighbour wants to buy your house. Your neighbour is both loud and emotional, shouting prices at you from over the fence. Sometimes he's happy to offer you a high price but at other times he's despondent, quoting a low ball price. It’s irrational behaviour (and you consider your house a long-term investment, anyway). But the benefit you have is you can ignore your neighbour's quotes and act only when they’re interesting. If the price isn’t interesting today, we can see what he has to say tomorrow.
It’s an interesting analogy that’s relevant to the stock market. Just because the market is quoting a certain price doesn’t mean you have to be influenced by it. Depending on the prices you can ignore them or take advantage but the key is not being influenced by the emotional ups and downs. It’s up to us to decide if we want to take advantage of low prices or be influenced by them.
So what should you do in a correction?
You’re probably not a professional investor – and you’re not a robot either. As a living, breathing human with emotions, it can be hard to make decisions when you see your investments tanking.
It could be helpful to consider the following:
- Market corrections are to be expected. History shows that you have to go through the lows to get to the highs. Markets have historically incurred intra year drops of 14%, so we have to expect yearly short term losses and volatility. An intra year drop is the difference between the highest and lowest point in the market in a year. Shares have traditionally returned more than other assets but the price of these returns is volatility.
- Consider your goals. Short-term and long-term investors are likely to have different objectives. You may be able to withstand more volatility if you have a longer timeframe.
- Stick to your investment plan. If you planned to regularly invest for the long term, you may not need to do anything differently.
- Filter out the noise. Facebook groups, Reddit and Twitter are ever present methods you can use to freak yourself out. If you’re confident in your investments and strategy, don’t undermine yourself with constant noise.
- Consider utilising dollar-cost averaging. Set up a monthly or weekly investment plan that automatically invests on your behalf. Making your investment decisions automatic minimises decision fatigue and takes the emotions out of market volatility.
- Time in the market beats timing the market. Bryna from Spaceship wrote about this back in 2020 when we experienced similar market conditions. While past performance isn’t an indicator of future performance, we went on to reach new highs.
