It’s official: The stock market went into a correction this year. And pretty fast, too.
A correction is when the stock market has declined 10% or more from its recent high. It is measured by the major stock indexes such as the Dow Jones Industrial Average (DJIA), S&P 500, and the NASDAQ Composite.
For the investor who has never experienced one, a decline like this is nerve-racking. For those of us who have been through a correction before, it’s still nerve-racking. But don’t panic.
When you invest in the stock market, you should expect corrections. They’re not uncommon.
In the 74 years since World War II, there have been 29 declines between 10% and 20%, according to research by Guggenheim Investments.
The average length of decline was four months, and the average time to recover was another four months. Bear markets — that’s when the market declines by more than 20% — have happened 11 times in the past 55 years.
Stock market returns are not always positive
Have realistic expectations for your investment returns. Expect some years with negative returns, because corrections and bear markets will happen. Not every year will have a 10%, 20%, or 30% return.
However, history has shown that investors who hold on during corrections are rewarded. The average annual return of the S&P 500 between 1928 and 2019 (including dividends) was positive: 11.57%, according to data provided by NYU Stern School of Business. This includes both the good years and the worst years of the Great Depression.
Investing is for long-term goals
Only invest in the stock market for long-term goals.
Don’t risk any money you need within the next 12 months. You don’t want to find yourself short of cash when you need it because of a sudden correction.
Instead, invest in the stock market for far-off savings goals such as retirement or higher education. This leaves time for your investments to recover after a correction.
Don’t try to time the market
Trying to predict market corrections is not a good investment strategy for everyday investors. We know it will happen, but we don’t know when.
I remember hearing opinions that we were due for a correction when the Dow Industrial Average hit 20,000 in 2017, then again at 21,000 and 23,000 and 25,000 and 27,000 and so on. Waiting on the sidelines for a pullback may cause you to miss potential gains.
Trying to predict the bottom is just as difficult. If you hold back your investments waiting for the bottom, you could miss the rebound and the days with the greatest returns.
The best way to manage the risk of investing in the stock market is to follow simple and prudent investment principles. Diversify your investments, have the right assets allocation (stocks, bonds, cash), and — I’ll say it again — only put money in the stock market for your long-term goals.
You still earn dividends
Even when the stock market is down, mutual funds, exchange traded funds (ETFs), and stocks — the vehicles you invest things like 401(k)s and 529s in — still pay dividends.
Price appreciation is not the only way to get a return on your investments. If you own dividend-paying stocks and mutual funds, they will continue to pay the dividend regardless of the price.
Having dividend-paying investments in your portfolio can enhance your return and also buffer your portfolio during volatile markets.
To make the most of your dividends, set up your accounts for dividend reinvestment. That way, when your stocks or mutual funds pay a dividend, it automatically reinvests at the current price. And when the market is in a correction, your dividends reinvest at a lower price.
401(k)s and 529 plans are likely set up for dividend reinvestment automatically. But accounts held at brokerages, mutual fund companies, and other financial institutions will need your direction. It’s easy: Just contact your firm, or look for instructions on its website. Setting up automatic reinvestment is usually as easy as clicking a button.
The stock market is on sale
Not a good idea.
Imagine going to your favorite store and discovering everything is on sale. What an opportunity! You’re able to buy what you want at a discount. Would you hold off until prices return to where they were before? Probably not.
Every time you make a contribution to your 401(k) or other investment plan during a correction, you’re buying at a discount. This makes market corrections beneficial for long-term investors, because the value is bound to go up in the long run.
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