Financial Literacy Friday: Market Corrections
Welcome back to another Financial Literacy Friday, in today’s post I’ll be focusing on market corrections. While the term “Market Correction” can seem fairly innocuous, they can have relatively large impacts on your investments and can be a signal of things to come. While these corrections can negatively impact your investments, they can provide a number of positive outcomes based on your mentality, so I’ll get into that aspect as well. First, let’s talk about what a market correction actually means.
The Correct Correction
The technical definition of a market correction is an almost always temporary reverse movement in the value of an equity that accounts for a 10% change in pricing. Market corrections are simply short term (usually negative) changes in prices that occur when certain equities are considered to be overvalued by the market as a whole. They can happen to stocks, bonds, commodities, or even an entire index which results in a not-insignificant drop in investment value. The US stock market has experienced 36 market corrections between 1980 and 2018 which makes for just about one a year, so they are not uncommon. These corrections typically last about 3-4 months at a time which can be a big deal to a short term investor as that’s a significant chunk of value over that much time. However, for someone who is going to be invested for the next 10-20 years it barely registers as a blip in their investment experience. While the market is relatively stable over the long term, in the short term there is a considerable amount of volatility in market prices. This short term volatility can be looked at a few ways, which leads us to the different mindsets when market corrections happen.
I already discussed the difference that market corrections can make for those who are short term vs long term investors, but let’s take a closer look into how these corrections can affect your mindset. You now know that these corrections have happened almost once a year since 1980, and the market is the strongest it’s ever been. That means that it’s reasonable to believe that these corrections will happen in the future and that they won’t torpedo the value of the market going forward. That means if you’re invested in a broadly diversified strategy and have good and objective advice then these corrections likely won’t send you to the ledge. However, these corrections also represent an opportunity, as valuable assets lose price quickly it allows for someone with the available capital to purchase those valuable equities at essentially sale prices. We know that these corrections last about 3-4 months, so being able to absorb the short term losses and take part in the sale can lead to much higher returns in the future. Mindset is so important in investing and can be the difference between constant anxiety and being able to take advantage of what’s happening.
Have you been invested during a market correction? What did you do? Have you thought about what your plan is for the next correction? Send me an email and I’d be happy to talk about strategies for dealing with the ups and downs of the market.