Even if you’re entirely new to investing, you’ve probably noticed that when the markets are rising for an extended period of time, the media starts talking about when the correction is likely to occur.

Due to the quirks of human nature, every correction feels novel and scary but they all have similarities.  They say the past doesn’t repeat itself, it rhymes. At this moment in time, the Fed determined to raise interest and start selling its massive book of government securities in an effort to reign in inflation. This has the potential to dampen economic activity in time and bring down an overheated economy to reduce inflation. 

The Fed has a dual mandate, to keep inflation in check and to maintain a policy of maximum employment. They have a tough job now to bring down record-high inflation and at the same time not hurt the labor market. This is referred to colloquially as the ‘soft landing’.

If you don’t have a lot of experience in the financial world, you may be left wondering what kind of correction they’re talking about. This article will tell you all about market correction — what it is, how long it lasts, and what to do when it occurs. Keep reading to learn more!

What Is a Market Correction? 

A market correction is a decline in the value of a market index, like the S&P 500. Compared to a recent peak, a correction is typically a drop in value between 10% to 20%. Corrections also happen to individual shares, assets, and even commodity indexes. 

You can think of market corrections as an indication of a potential reset. In most cases, the US stock market gets a correction when a significant event shocks our society and produces an economic impact. That’s because, in such times, investors often pause and take a step back to consider how they can react to the new situation.

Corrections are also commonly regarded as cyclical, as the S&P 500 has a pattern of correcting itself by at least 10% every 19 months.

How Long Do Corrections Last? 

In most cases, a correction is a short-term move that lasts anywhere from a few weeks to a few months. As per Ed Canty, a Certified Financial Planner with CFM Tax And Investment Advisors, ever since World War II the S&P 500 index has needed, on average, around four months to bounce back from the correction and return to its previous highs.  However, you need to keep in mind that not all corrections are the same. Some can last three to four months, while others are shorter and have a duration of only a few weeks. 

Usually, once the catalyst event has settled down, the market will recover and start climbing higher again. But here, there are exceptions yet again;  since 1974, five corrections have turned into bear markets. Now, let’s take a look at what that means.

What Is a Bear Market? 

When investors say that the correction has turned into a “bear market,” they essentially mean that its decline in value has gone longer than it would with a normal correction. When a bear market occurs, the decline is usually more than 20%. Additionally, bear markets are typically longer, going on for more than a year in most cases. Bear markets happen when more significant changes occur in society. If a correction is a representation of a moderate amount of concern for some events, a bear market is associated with a deeper, longer-lasting issue that can result in an economic crisis. 

When a correction occurs, investors remain optimistic about the future and the earnings that are expected to recover in short order. They come back to the market quicker to buy shares at lower prices while considering when the market will start rising again. This is the well-known phenomena, “buy the dip, sell the rip”

On the other hand, the whole outlook on the economy changes during bear markets, and investors are more unwilling to take risks. And so, even after prices have gone down, they remain uncertain and sometimes even stop investing for a while. Bear markets are borne of deep uncertainty. We are in a bear market now in my opinion, even though the S&P 500 hasn’t quite breached the 20% losses from peak to trough. Half of all Nasdaq stocks are down 50% or more.  That’s plenty enough to instill deep uncertainty.

What to Do When a Market Correction Occurs 

If you’re new to investing, the premise of market corrections and bear markets may make it seem like you’ll lose your money during these periods. However, that’s not always the case. You’re likely to continue doing well with the right approach, even when a correction occurs. That is why qualified investors are the ones who invest by using logic and not just by trusting their instincts and relying on their emotions.

Here is some advice to follow when a market correction occurs that can help you get out of the situation as a winner.

Figure Out the Cause Behind the Correction 

Before making any decisions, you first need to take a look at what’s happening and do your best to understand what’s causing the correction. If you see that the changes happening are nothing major, then you can assume that the correction will be short-lived. On the other hand, if there have been changes that are impacting broader stock markets, that’s a sign that you might have to prepare for a longer correction period or even possibly a bear market. 

That doesn’t necessarily mean you should start selling your assets, but you might want to consider adjusting some parts of your portfolio to reduce the need to sell assets, which could potentially bring you losses.  If you own index funds like most investors, your stocks are going to act monolithically.  Remember there are always some group or individual stocks that might be on the right side of the economic downturn. Weight your investments toward those groups and avoid the ones being economically punished. The best returns in the market are those years coming out of recession. If you’re not invested, you’ll miss these sharp moves. It’s a well-known fact that most of the moves in the market come in short violent duration.

Keep Money Close and Pay Attention to Dips

A huge part of being a good investor is making sure that you have enough cash to make it through any dips without reaching for your investing dollars. It’s a good idea to have an extra fund that’s ready to support you and that you can use when the market is in a correction. Additionally, you can use this money to take advantage of dips. One of the things that I do is examine what insiders are doing with their own money.  No one has a better read on their busines prospects and the relative value of their stocks than the corporate insiders running the company. On the other hand I mostly ignore institutional or hedge fund buying. They represent largely other people’s money and are not as vigilant as the CFO who might have a second home, two kids in college to pay for, and already most of his compensation tied to his company’s stock.  When he/she buys a material amount ($200k or more), I pay a lot of attention.

When prices drop, consider how you can take advantage of the situation by investing more each month or buying a particular stock at lower prices, also called “buying the dip.” As we know from the long history of investing, the prices will likely start rising again sooner or later, meaning it’s often not the best move to pull out your money whenever there’s a market dip. 

Make a Strong Portfolio that Can Tolerate Risk

As an investor, being proactive is the key to being successful. Especially if you anticipate that a market correction might occur, it’s a great idea to shape your portfolio by allocating assets to fit your future financial goals and your level of risk tolerance. This will help you minimize emotional decision-making once the correction happens. 

Most people who have purely aggressive portfolios suffer losses by trying to change their entire investment strategy while the correction is ongoing. As an investor, you have to expect that moments like these will happen, and you have to be ready to face them. 

However, if you are new to the world of investing, your first market correction will likely be the first time the reality of the matter really hits you. In the end, this is a good thing, as it can help you determine your own level of risk tolerance going forward. It may be the case that a correction helps you realize that you need to invest more conservatively, as you’re unable to deal with the idea of losing too much money. 

Reevaluate Your Risk Tolerance Every Year 

The amount of risk you’re willing to take with your investments will probably change over the years, months, or even days.. When you’re younger and have more time, freedom, and fewer responsibilities, you might be willing to risk more. However, as you grow older and need to start seriously thinking about retirement and supporting your family, you may want to reconsider the amount of risk you’re taking. 

That’s why it’s a good idea to take a look at your portfolio every year and adjust the risk level you’re taking. For example, when you’re nearing retirement, you may want to reduce the percentage of your portfolio in stocks to minimize the risk. That way, the potential lows won’t impact you as much. 

As you can see, by taking a proactive approach and actively managing your portfolio, you can survive a correction without any huge consequences. 

In Conclusion

Corrections are entirely normal and entirely painful. They occur relatively often, so as an investor, you’re bound to see more than one or two in your lifetime. That’s why it’s good to be prepared for when they come around. The best that you can do is adjust your portfolio proactively and stick to your long-term investment plan.

If you feel like you’re currently unequipped to handle everything that comes with market corrections on your own, then Alpha Wealth Funds is ready to help out. Our investors have decades of combined experience and are experts in every sense of the word. Contact us today to discuss creating a portfolio that can survive any corrections and is adequately adjusted with your financial goals in mind.  

Please feel free to reach out to me on this or any of your investment needs or questions. I may not always have the answers at my fingertips, but I promise I will get them for you. Harvey Sax

Founded in 2010, our services include boutique hedge funds, separately managed accounts, financial planning, estate & trust services, private placements, and in-house concierge services for high net worth individuals, families, and businesses.

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. All investments involve risk including the loss of principal.