None of us knows when the next market correction is coming, but we do know that it is coming.
Instead of panicking when markets take a dip, why not prepare yourself for the inevitable? Like my Dad always used to say: forewarned is forearmed. Knowing what to expect makes all the difference in the world, so here are a few concepts to wrap your head around before the next correction comes.
1. Corrections are a normal part of investing. There is an averageintrayear peak to trough correction of about 14%! In other words, during an average year, markets will climb to a peak, only to fall back 14% before heading upwards again.
2. Higher market valuations translate into bigger point drops. Fourteen percent of the DJIA, which was valued at nearly 21,000 at a market peak in early March, would be over 3000 points. The same percentage of the S&P 500’s valuation would be almost 325 points. The higher markets go, the bigger the point drops will sound to us, even when they are just average.
3. When this incredibly normal 14% correction of the DJIA happens, it will be reported as the end of the world. Some pundit somewhere will claim this painful correction is proof of Trump’s shortcomings. Others will warn that our economy is headed for the flogging the so-called “smart money” has been predicting for years. Quite a few of of them will insist that you’d better do something different if you don’t want to lose everything!
And nothing could be further from the truth, in my humble opinion.
Don’t get me wrong. I am not a fan of Trump or his policies. But I do not believe for a minute that the most liquid and profitable companies in the world, which are run by the most rational and profit-motivated leadership in the world, can’t figure out a way to manage around the likes of Trump.
When the unpredictable but inevitable market correction comes, Trump may very well be wreaking havoc in the world, but the correction will happen because it is time for a correction. The sellers will start outnumbering the buyers, which will naturally force the price of shares downward.
For how long? Until buyers again recognize the value of those shares and begin snapping them up at “bargain” prices. The more market pundits fan the flames of fear in the shareholders and drive them to sell, the bigger the “bargain” will be for brave buyers.
But what if this isn’t an “average” annual correction? Well, historically, about every two to three years we’ve seen the value of shares drop by at least 20%. At those peak valuations from early March, that translates to a 4200 point hit to the DOW and 500 points to the S&P 500. Ready to hear some even more impressive numbers? Roughly every five to seven years you can expect a “big one” – a correction that reduces equity values by 33% on average. Of course, sizeable corrections happen with such regularity that it kind of diminishes the meaning of “big one.”
Although a 7000-point drop on the DOW and an 800-point hit to the S&P 500 may sound huge, remember that we’re talking about current market valuations. Don’t let the numbers fool you into thinking something unprecedented is happening. These average market corrections are completely normal.
The last two biggies (Dot-com collapse and the Great Recession) took us into negative territory by over 50%, and now the markets are flirting with all time highs. Thus far, every time we’ve experienced a sizeable correction, markets have recovered in the fullness of time.
Patience, not fear, has won out.
So how should you respond to a 3000 point drop in the Dow? Mindfully stick to your financial plan, and I think you’ll be just fine in the long-run. Save what you are supposed to save. Invest what you are supposed to invest. Stay broadly diversified and rebalance your portfolio every year, in good markets and in bad.
If you want to be even better than fine, take the next step down the path of mindfulness: Make a conscious, deliberate decision to resist panic and the deeply emotional and immediate need to react whenever markets take a dive. It’s tempting but foolish to believe you’ll be able to get back in or out at the “right time.” You won’t, so why waste precious time thinking about trying? Responding with a calm, cool, level head works much better than reacting, in my book.
None of us knows when the next market correction is coming, but we do know that it is coming. And we also know that the pundits will proclaim that “this time is really different.” If you can remember that this time is really average, and adopt my market mantra of “this too shall pass,” you should find it much easier to navigate the next correction!