As I write this, the media is full of scary stories about an imminent stock market correction due to the recent uptick in volatility and distance from the last market downturn.
I’d like to offer some perspective on what a correction is and what it really means for investors. Hopefully this will bring greater confidence to your investment plan and keep the emotions out of your decision-making process.
A stock market correction is defined as a 10 percent or greater pullback from market highs. A bear market occurs when the market falls more than 20 percent.
Corrections are surprisingly frequent, with one occurring on average every 18 months since 1950. The last correction was in the summer of 2011 and got close to bear market territory with a 19-percent decline.
Corrections frequently happen when the market has had a good run and investors begin to take profits and reposition investments. Sometimes events or economic data cause the decline, but corrections usually do not predict a recession. Most occur in times of expansion. Most times the market recovers its correction loss within three months of the bottom.
It certainly can be disappointing — even gut-wrenching — to see your investment values fall from their lofty perch. But it is an inevitable part of the investing experience.
Nobody can predict when the next correction will occur or how deep it will be. The noise the media makes about an impending correction is simply a guess that is frequently wrong.
I recently saw Warren Buffett discussing how his company, Berkshire Hathaway, has declined 50 percent or more four times over his investing career.
Buffett is generally considered one of the greatest investors of our time and even he could not predict the fall in his own company’s shares. How can the news media know so much more than Buffett about the direction of the market?
If a correction is not predictable or avoidable, what steps should you take to deal with these inevitable declines?
The most important step you can take is to be certain that your emergency funds and short-term income needs are not invested in the markets at any point in time. If you know that you have these funds secure, you are much more likely to ride out short-term volatility in the markets.
Second, I believe it helps to know and be comfortable with what you own. If you understand the businesses you own shares in, declines in price may be viewed as an opportunity rather than with fear.
Lastly, do not emotionally make long-term decisions based on short-term events. Remember: if you do sell your investments in a correction, how will you know when it’s the right time to get back in? Being out of the market can also present a danger to your long-term goals.
Knowing corrections are a normal part of the investing journey should help you keep your eye on your long-term goal. Clear, unemotional thinking can help you deal with these declines and may help you spot opportunities for the next market rise.
John Burdette is a financial adviser at Fourth Avenue Financial in South Charleston.
Disclaimer: Securities and advisory services offered through National Planning Corp. (NPC), member FINRA/SIPC, a Registered Investment Adviser. Fourth Avenue Financial and NPC are separate and unrelated companies.