Stock Market Corrections & Your Investment Strategy

laptop on a granite counter with stock market graphs on the screen and a book and iced coffee next to the laptop

For many, it’s hard to forget the stock market crashes of 1987 and 2008, the tech bubble burst of 2000, or even the mortgage crisis. If you’re worrying about the market’s recent swings, consider taking a deep breath, remembering what we can learn from history, assessing your long-term plans and implementing some grounded, common-sense steps.

Here’s What We Know from History
Market corrections are normal.  If you consider the long-term upward trend of the stock market versus other investments, you’ll see that within a few years of a severe market correction, most investments recover. No one knows exactly how long it will take – even the best analysts, who try to predict the peak or the bottom of the market, never know whether their predictions were correct until time has passed. Some market corrections are indeed more significant than others, but the important concept to remember is that financial markets go through cycles.

Still, the question that many may have is what if you didn’t plan ahead for a market crash or get your finances completely in order? What do you do? Begin with the basics.

Stocks, real estate, bonds or other investments have specific sectors or regions that may be impacted at any time, but when there’s an overall drop in prices across an index of 10% or more, experts consider it a market correction. Many types of perceived risks can cause investors to sell. Political risks, widespread pandemic fears, business risks and other factors can cause investor panic. In our recent history, anything from a change in the presidency to a potential threat of a virus can be blamed for market upheaval.  Whether rational or irrational, it can drive down the prices of stocks. So, what can you do?

Create a Plan (or stick with your plan) & Get Help If You Need It
Prepare for the days when the market is down.  It is great to pat yourself on the back for your decision-making on a good stock market day, but you should also expect that even if you make amazing choices on your investments, you will still have some days that are frustrating.

You’ve probably heard the old investing mantra, “buy low” and “sell high”, but many don’t have the stomach for waiting it out.  Investor behavior and emotional reaction are often to blame for irrational decisions. Too many investors sell at market lows when they feel they have to “get out” before the market goes any lower.  Later, when there’s an upward trend, most investors tend to “get in” close to the top of the market cycle. This phenomenon can lead to lower-than-average returns over time.

Avoid trying to “time” the market by selling or buying strategically.  Instead, stick with your plan. You may want to consider funds that have a target date in the future which corresponds to the earliest year that you would withdraw the funds.  Using a fund management team that rebalances your account over time takes some of the emotion out of investing in this type of fund. If you get stressed or uneasy and need someone to talk you out of possibly making poor choices, or simply want to get an expert opinion, consider working with an investment advisor.

Start or Build Emergency Savings
Having cash available if you need it will provide you some peace of mind.  If your household suffers a loss in income, if you get a large medical bill or you want to take advantage of the discounted prices on stocks, you will have savings to do it.  Just make sure you always keep enough cash to cover expenses for 3-9 months or keep building the account until you do.

Start or Continue Dollar-Cost Averaging
Dollar-cost averaging is consistently contributing to your investments regardless of market prices. This means that you’re buying when prices are low and when prices are high, rather than trying to buy on “the right day”.

The good news is that when the market drops due to a correction, it means that prices to buy are lower.  If you have the funds available, it is an opportunity to buy great companies when they cost less. Be brave and start (or continue) investing with every paycheck.

An example of dollar-cost averaging is a consistent contribution to a 401(k) or other retirement plan, which means that you will buy when share prices are low, and as the market recovers, you will purchase shares at a higher price.  Over time, the share price will average out.

Also remember that if you receive an employer match to a retirement plan, you have “free” money that provides an instant return for the dollars you invest.  Take advantage of this benefit by contributing at least the minimum amount to receive an employer match if your employer provides a matching contribution.

Time Frame – Plan for the Long-Term
If you did some planning prior to starting your investing journey, you will remember that any money invested in the stock market should be long-term dollars that you don’t need to spend this year, next year, or even five years from now.  If market ups-and-downs make you nervous, remember that you won’t be using this money for many years from now.

If you do have a need to use some of your investment money, consider the time frame for when you will use it. Money needed within a year to five years should not be invested in the stock market.  It should be in a safe, liquid account that can be accessed without penalty. An example of this would be your emergency savings: be sure to have emergency savings to cover living expenses of three months or more, and never invest emergency savings in anything other than a cash or cash equivalent account. If you need to use some of your emergency savings, you want to know that the full amount is readily available.

Asset Allocation & Diversification
Having the right mix of investments for you means a balance of taking some level of risk in an effort to gain a higher return and beat inflation, but you will want to carefully consider your time frame until you plan to use the money.  As you think about your comfort level with risk, along with your time horizon for the investments, you can complete an asset allocation questionnaire to come up with a balance of investment types and percentages in each investment category like stocks, bonds, and cash.  By having a mix of investments, you balance out some risk by being diversified or avoiding having “all of your eggs in one basket.” Most experts recommend no more than 10-15% maximum in any one investment, to reduce your exposure to risk. This includes company stock, which many employees tend to hold, especially if it has performed well.

Stay Calm & Invest Only in What You Understand
Just as it can be scary to look at your account statements when the market is dropping, it can also be easy to get caught up feeling like you are missing out on the next hot investment if the stock market is recovering.  If you are the type of person who doesn’t want to miss out, try to exercise some caution. Avoid investing based on hype over a new tech start-up or emerging industry. If you decide it is time to invest, do your research and if you don’t understand it, you may be taking risk without knowing it.  Consider working with an investment advisor if you are not confident in your ability to research investments and to understand all of the possible risks.

The next time you see headlines about a stock market correction, keep in mind that it is temporary and just a part of the market cycle. By taking steps to create a plan and prepare to patiently wait out a downturn, you can stick to your long-term plan.

Talk to a Money Coach Today
Do you have questions? Want more details? For investing tips and education, talk with your Money Coach. They do not provide specific investment advice, but they can help you better understand the options, so you can determine the best step forward for your financial goals. Partner with your personal Money Coach to do the following:

  • Start and build emergency savings
  • Look at cash flow and what’s available to invest
  • Review your asset allocation
  • Create an action plan

Call 888-724-2326 today to get started.