The financial community defines a stock market decline of more than 10 percent in value as a “correction.” Such an event, both before and when it actually happens, can cause you to feel alarmed to downright terrified.
Despite this, I suggest that investors, particularly the buy-and-hold type, put their fears aside and not be overly concerned about a so-called market correction.
Corrections won’t crack a balanced nest egg
For starters, the “market” we are talking about is the one for stocks, not bonds. Assuming that your portfolio features a moderate asset-allocation as described below—somewhere in the range of a 60% - 40% stock-bond split—market corrections will only affect a portion of your overall nest egg.
Corrections are a certainty...just like death and taxes
Secondly, market corrections are an inherent part of the investing process and occur on a fairly regular basis. Simply stated, a stock market correction is an inevitable part of stock ownership. However, as an exception to the rule, the U.S. stock market has been pretty tame on the downside since 2011. As a result, investors have had little experience lately with a down market.
MARKET FLUCTUATIONS: A HISTORY OF DECLINES 1900 – 2015
% DECLINE AVERAGE FREQUENCY AVERAGE LENGTH LAST OCCURRENCE
-5% About 3 times a year 47 days August 2015
-10% About once a year 115 days August 2015
-15% About once every 2 years 216 days October 2011
-20% About once every 3.5 years 338 days March 2009
As I write this article, some stock valuations are hitting historical highs on a regular basis. So it comes as no surprise that the financial media is full of predictions about when, not if, a market correction will occur.
And, based on historical trends, one could reasonably assume that we are overdue. On the other hand, one could also argue that we have been here before. Recall the year of 1996 when we had 15 years of steady growth behind our backs, resembling our recent S&P 500 run. Who would have ever guessed we would see another 4 years of strong stock market return? Bottom line, we simply cannot predict a correction. When it happens, you’ll know it. No need to spend time and energy worrying. Instead, invest with the long term in mind.
If you have high-quality investments, don’t be tempted to tinker with your portfolio. Experience shows that a correction’s “bark” is worse than its “bite.” Long-term investors can actually view a correction as an opportunity to add new money to proven investment positions at favorable prices.
Corrections can be erratic . . . like temperamental toddlers
Thirdly, just as market corrections cannot be predicted, no one has ever been able to predict how long they will last or how deep (percentage decline) they will go. The takeaway here is that you should not try to time the market. Getting out when the market falters and getting back in when it rebounds is a losing proposition.
Corrections offer a second chance to rethink your holdings
Fourthly, tracking how your stocks and stock mutual funds perform (loss and recovery of value) during and after a market correction provides investors with an opportunity to assess the defensive and offensive strengths of individual holdings. It’s also a good time to revisit why you bought and continue to hold the various holdings you have in your portfolio.
It’s not easy to decide what to do, or what not to do, when faced with a market correction that affects you directly. My advice is to first make sure the situation is being analyzed by using the reflective, left side of your brain. Restraining the brain’s reflexive, right side will take the emotions out of the decision-making process.
Limit worries with a balanced portfolio
If you have a reasonable asset-allocation for your time horizon, you’ll have less to worry about than investors with stock-heavy portfolios who need to begin withdrawal within a few years. To illustrate this point, let’s look at the historical performance record of a moderate allocation mutual fund in relation to some notable stock market declines.
The fund in question, Vanguard Balanced Index (VBINX), maintains a steady 60% - 40% stock-bond portfolio mix by following total stock and bond market indices. The Fund is highly rated by Morningstar and has a solid long-term track record: A 10-year annual average total return of 6.23% with a below-average risk and an above-average return category-comparison rating.
VBINX accomplished this respectable performance while enduring three market corrections in 2008, 2011 and 2015. If you invested in this Fund during those years, you would have had to live with annual total returns of – 22.21%, + 4.14%, and + 0.37%, respectively. Just remembering the negative 39% stock market drop in the 2008-2009 period should be sufficient evidence to substantiate the value of asset-allocation when it comes to protecting financial asset values.
In summary, I believe it’s a waste of time to worry about market corrections. Not because they won’t come – they will. However, following Vanguard founder John Bogle’s advice to “stay the course,” a reasonably balanced portfolio of high-quality stock and bond investments will lessen the damage, strengthen a recovery of value, and justify a long-term, buy-and-hold investing strategy.
Source of Market Fluctuation data:
American Funds website. “Market Declines, A History”, Source: The unmanaged Dow Jones Industrial Average, https ://americanfundsretirement.retire.americanfunds.com/basics/volatile-market/market-declines
All investing involves risks. Past performance is no guarantee of future results.