I was in the Brainerd lakes area on August 20th enjoying the last few days of our Minnesota summer when I received a notice on my phone that the market was down 355 points. 24 hours later it dropped another 531 points. By the market open on Monday, August 24th the Dow Jones Industrial Average had shed nearly 2,000 points in less than three days.
My quiet wind down to the end of summer quickly came to a screeching halt.
The markets were officially in a correction. A market correction, defined as a drop of 10% or more from previous market highs, was long over due. The last one occurred in 2011, almost 4 years ago. Historically, these things happen much more frequently.
The general feeling of most of my clients has been concern, not panic. Truth is, most of us have been through this – and a lot worse – before. Some of us have been through it a few times.
Nevertheless, market corrections are scary and they always come with a heavy dose of uncertainty. No matter how experienced an investor you are or how unemotional you may be, seeing the Dow drop nearly 2,000 points in just a couple days gets your attention.
Markets never go straight up. To paraphrase a popular saying, mayhem happens.
Here are 5 ways you can manage market mayhem when it comes your way.
Keep your cool. Market corrections are a normal part of investing. According to information provided by Bloomberg News, there have been 19 years since 1980 in which the S&P 500 has sold off by 10% or more at some point during the year. In all but 6 of those years, the market finished with a positive return for the year. On average these periods last about 14 weeks and were typically followed by a strong market rally. Of course, the past is no guarantee of the future, but statistically the odds are in your favor to ride things out.
Remind yourself of your time horizon. In a recent blog post, I argued that you should plan to retire sooner than you think. I still feel that way, but for most of us retirement is still several years away. Even if you are already retired, you won’t need some of your money for another 5, 10, maybe 20 years or more. The longer your time horizon, the more you can afford to wait out a market correction.
Get a gut check on your risk tolerance. Market corrections provide a great way to assess your true tolerance for risk. In my experience most investors claim to have a “moderate” risk tolerance and can withstand a certain amount of market volatility. But when you see your account balance shrink by tens of thousands of dollars in a day, its amazing how fast moderate turns to “conservative”. No one likes to lose money, but wide swings in your account balances come with the territory when investing in the stock market. If a 10% drop in the S&P makes you
swoon, you may want to consider reducing the percentage you allocate to stocks in the future – after the markets and your account balance have recovered.
Look at corrections as opportunities. Market corrections offer a silver lining. When market values decline, stocks and stock mutual funds become cheaper to buy. The only thing we know for sure is that the price of your favorite stock or mutual fund is probably less today than it was a week or two ago. If you have money on the sidelines waiting to be invested, market corrections may present a good opportunity to buy in to the market at a discount from its previous high. Of course, the coming months could bring even better buying opportunities. You never know. That’s part of the short-term risk you take when you invest in the market.
Consider your alternatives. Sometimes it’s wise to focus on the return of your investment rather than the return on your investment. Certainly it makes sense to keep a portion of your assets safe and liquid. However, if your investment objective is to outpace inflation over time, you don’t have many alternatives. According to bankrate.com, the highest yielding 5-year CDs pay about 2.25%. Many banks pay as little as 1% or less. Bonds may pay more, but their value can fluctuate as well especially when interest rates go up. While stocks can lose significant value in the short-term, a well-diversified stock portfolio or mutual fund historically has been your best option for beating inflation over time.
As I write the markets have recovered more than half their losses, but my guess is that this isn’t over. No one really knows what will happen next or how markets will perform in the future, but the next time market mayhem happens you will know how to manage it.
For now I suggest you go back to enjoying the rest of your summer.