What can long-term investors do now that the overdue stock market correction has arrived?
Most everyday investors are investing with mutual funds and ETFs in their IRAs and 401(k)s. They’re not market timers with short-term perspectives.
Long-term investors can start by taking a deep breath. Short-term volatility is simply a natural part of the big picture that is long-term investing.
And all the media noise is not only directed at news of the moment, but it is also reactionary. Shouting to the masses that a massive storm just hit and caused billions of dollars in damage does nothing to help people pick up the pieces and move forward. The time to talk about storms is before they strike, not after the fact.
Perspective on Stock Market Correction History
On Monday morning, when I saw the Dow Jones Industrial Average drop 1,100 points in 30 minutes, my first thought was not about my own investment assets, but that I needed to reach my clients before the media does.
I drafted a quick letter that included a brief explanation about why stock prices are falling so dramatically, plus some market history on corrections.
Here are some of the points I made on market correction history:
- As of Friday afternoon, stocks reached what is called a 10% correction. This size of correction occurs on average once per year. However, by my calculation, there has not been a 10% correction in four years. This means we have been “overdue” for this decline for a while.
- The average recovery time for a decline of 10% or more is approximately 10 months. Also keep in mind that stocks prices have been generally rising for more than six years, which is the third longest bull market in history.
- Stocks, as measured by the S&P 500 index, doubled in value from March 2009 through 2013, and had an annualized return of more than 20% for the period. Results like this are unsustainable. The historical average return for stocks since 1950 has been about 10%.
What Long-Term Investors Can Do About Market Corrections
In my letter to clients, I went on to say that, for most investors, the best thing to do in this correction is nothing, because our portfolios are already prepared for this decline.
Living on the coast of hurricane-prone South Carolina, I know firsthand the importance of preparing for storms. Long-term investing is no different: You build a diversified portfolio that is prepared for any kind of environment and you don’t get out in the middle of a storm and try to defend against it.
Of course, prior to a hurricane’s arrival, there is at least a few days’ notice. But while there were some warning signs preceding the recent stock market correction, the extent of the damage took most investors by surprise.
So if you want to make a few repairs to your portfolio, here are some simple and smart strategies for long-term investors to take advantage of the market correction:
- Rebalance your portfolio: If you haven’t rebalanced in a while, chances are your stock allocation is significantly lower than it was a few months ago. Periodically buying the “losers” and selling the “winners” is a good idea, no matter what the market is doing.
- Dollar-cost average: If you’re already making systematic investments into the mutual funds and/or ETFs in your retirement plans or brokerage accounts, you might consider increasing the investment amount. If you’re not dollar-cost averaging, now is as good of a time as any to get started. Doing this will “automatically” buy shares of funds at various price levels. A DCA plan will take advantage of lower prices by purchasing more shares.
- Review your investment objectives and risk tolerance: If you are a long-term investor and you don’t expect to make any withdrawals for at least three years, you generally don’t need to sell stock funds now. But if you’re losing sleep at night about short-term declines in the value of your investment assets, it’s likely your tolerance for risk is too low for your current asset allocation. For example, if you can’t stomach a 10% short-term decline in account value, your stock allocation should be less than 50% of your total portfolio.
Bottom Line on Market Timing With Corrections
The resounding theme here is that long-term investors need not concern themselves with short-term market corrections. Although a 10% decline in value is not a happy event, to say the least, it is a natural one that should be expected once per year.
And for those millions of investors with mutual funds in IRAs and 401(k)s, keep in mind that mutual funds trade at the end of the day. Therefore, if you try to buy or sell based upon that day’s market direction, you could end up doing more harm than good to your portfolio.
For the vast majority of investors, it is wise to ignore short-term media noise and to remember that there are no “losses” unless you sell an investment at a lower price than you bought it.
Kent Thune is the owner of an investment advisory firm in Hilton Head Island, S.C. Under no circumstances does this information represent a recommendation to buy or sell securities.
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