As of today, the Dow Jones Industrial Average has erased all of its gains this year. We’re not quite in “market correction” territory, though. The S&P 500 is still up year-to-date, but it isn’t presenting as fantastic a return as was evident earlier in the year. We could be getting to the point where the market finds itself in the midst of a market correction.
I wouldn’t pretend to be able to predict the daily, weekly, monthly, or annual swings of the stock market, but there’s no reason to rule a correction out as a possibility. Investing professionals typically define a market correction as the point at which an index that measures broad market performance is down 20 percent from a high. The Dow would have to be below 14,000 for there to be a market correction (and that would be down 20 percent from high of 17,279.74). The Dow could theoretically get there.
And if something is a possibility, it’s good to plan for it in advance. Here on the east coast of the United States, residents are prone to hurricanes. The good thing about hurricanes, and where they differ from stock market corrections, is that there are warning signs. If you pay attention to the weather segment in the news, you should know when a hurricane is going to arrive.
Before the destructive weather arrives, you have time to go to the store and buy water and food, nail boards to your windows, or evacuate. There’s little excuse for waiting until the last minute in most cases.
There are claims that there are warning signs of a market correction well in advance of a stock market crash (if the correction happens to come with one). But these claims generally come in two different situations. The first consists of those claims by people who are always predicting a correction is nigh — a broken clock is correct twice a day. The second consists of “experts” who point out the signals after the fact but were suspiciously silent while the signals were supposedly present.
Because markets generally operate in cycles, corrections are bound to occur. We just don’t always know when. So it’s good to know what to do ahead of time so you’re not searching for information in a moment of panic. If you just begin your planning during a moment of market panic, you’re going to find information from other people who are also affected by the panic.
And panic has never done any good for anybody, at least not with financial decision making. Panic supposedly developed as a biological response to physical threats and real danger. Panic causes adrenaline to pump through our bodies, increasing physical strength and agility in times of danger — like when you suddenly need to outrun a lion. Good luck with that. We haven’t adapted biologically to emergencies of a more cerebral nature, and that’s when panic fails us.
Before you think about taking any action with your finances during a correction, it’s good to know that corrections are not bad. The only reason the stock market is, in general, such a good place for investing for the long term is because of the corrections.
If the stock market offers an average of 8 percent returns over the course of any thirty-year period, it’s thanks to the occasional opportunities to invest during market corrections. If you want to get the market returns promised by financial planners, you have to be invested and continue to invest during times when newscasters and talking heads on television are concerned about the future of the economy.
Knowing what to do during a market correction starts long before any market correction. If, during the good times and bull markets, you create your plan to consistently invest a portion of your income, there’s no need to change course just because the stock market dips. In theory this makes sense, but in practice, there can be some complications.
Here is the one thing you need to do during a market correction.
Continue your investment plan.
One might say this isn’t an action to take, but a state of being to continue. Your ability to earn good returns in the long term relies on your willingness to continue your plan when the market is showing no sign of recovery. And this isn’t as easy as just tuning out the noise and leaving your automatic investment plan untouched.
Just think back to the recession of 2008. Those who invested through the recession came out on top, even with the Dow down for 2014 so far. But many people lost their jobs during the recession. Many couldn’t find work for a long time, and some are still out of work. Many graduates college between 2008 and today and haven’t had the opportunities others have had to continue — or even — start investing during a period of time in which investing in the overall stock market was crucial for receiving the best long term gains.
(Don’t worry if that’s you, and if you’re still young. There will be more opportunities in the coming decades.)
Some workers, perhaps because they were unable to maintain their jobs during the recession, retired early during this time frame. They retired early not necessarily because they were financially independent, but because the job market was unfavorable to men an women of a certain age looking for work. Some just gave up on the job hunt and learned to make do with a smaller nest egg than the one they were hoping for.
Even though just continuing your investing plan doesn’t sound like an action you take it’s absolutely necessary for coming out of a market correction with an advantage. It’s not even an advantage — it’s the baseline.
If you want those advertised market returns, don’t change your plans when the world of the stock market is crumbling.
So, when the world is shouting at you that the stock market is a terrible, horrible way to invest, how do you get through it and take advantage of a correction? The answers all require starting now, before the correction.
- Save during the good times. The character of Joseph in Joseph and the Amazing Technicolor Dreamcoat (I also hear he was in a prominent figure in another book) seemed to have the plan down and could probably offer some lessons to today’s CEOs. Use your profitable times to set aside some of your surplus money for difficult times. Create that emergency fund that will help support you in the case of a break in your income.
- Make your investments automatic. Don’t worry about individual stocks unless you have a small percentage of your portfolio you want to “play around” with. Choose a broad, low-cost index mutual fund like VTSMX. Start with your 401(k). Your employer will set that up for you if it hasn’t been done already. If you max out your tax-advantaged investment options, Vanguard will help you set up a recurring purchase of a fund every time you receive your paycheck’s direct deposit in your checking account.
- Rebalance your investments automatically. Your 401(k) administrator may be able to set this up for you. And it’s only necessary if you’re investing in a basket of funds rather than one index fund. But if you do invest beyond your 401(k), you might need to rebalance manually. Twice a year is all that’s necessary. Don’t even worry about rebelancing during a market correction if you already have a schedule.
- During the correction, tune out the noise. If the stock market is making headlines in non-financial news, everyone is going to be talking about their investments. And they’re going to be offering you advice, telling you what to do. Just ignore it. Turn off the television. Avoid social media. The less you’re exposed to panic, the less of a chance you’ll feel you need to change your plan.
How do you maintain your sanity during a stock market correction? Share your tips for investing here.
Published or updated October 20, 2014.