Should We Worry About Market Corrections?

Jan 2022

As I write this, financial markets are under pressure and down around 9% or more, depending on which market index you follow.  The NASDAQ Index is already down about 13%!  The reasons range from persistent inflation fears to the Federal Reserve’s plans to combat it, among other concerns.

Regardless of the reasons for these declines, markets tend to drop more regularly than many investors realize.  As a result, market pullbacks, defined as declines of 5%, and corrections, defined as declines of 10% or higher, are always alarming to investors.  When they happen in a short time frame, emotions run hot and fear erupts.  However, history shows these fears to be overblown.

The great thing about the stock market is its rich history of information.  This helps us understand long-term trends in bull markets, bear markets, and everything in between.  As an example, the table is telling:

Stock Market Losses: 1928-2021

   Losses          % of Years

5% or worse              95%

10% or worse             63%

20% or worse            26%

30% or worse             10%

These averages trend slightly higher because of all the crashes during the Great Depression period of the 1930s.  Still, stock market losses are a common occurrence even in more recent times, as you can see from the graph below. Each bar shows the S&P return for the given year. The corresponding red dots show the greatest market drop during that same time. As you can see, even in years of high returns, there were market drops.

Not only is the average yearly decline 14%, but annual returns were also positive in 32 of the past 42 years!

Moreover, since 1950, the S&P 500 Index has had an average decline of 13.6% per year.  And over these 72 years, there have been approximately thirty-six double-digit corrections (10% or more), ten bear markets (20%+ declines), and six crashes (30%+ declines).

On average the S&P 500 experienced:

  • A correction once every two years (10%+ drop)
  • A bear market once every seven years (20%+ drop)
  • A crash once every twelve years (30%+ drop)

Unfortunately, we can’t add these occurrences to our calendars because they occur randomly.  However, an old saying—“History does not repeat, but often rhymes”, is something to remember as we go through turbulent markets.

So, what can we do about it? Well, there are some proven ways to manage market fears. Here are some suggestions:

  • Make a Game Plan.  It is important to remember why you invest and how long you plan to invest.   Suppose you are still working and saving money in a retirement plan like a 401(k) or other investment accounts.  Put your retirement on auto-pilot and invest a set amount each month, quarter, or year.  You can do the same with other investment accounts like Roth IRAs and nonretirement brokerage accounts.
  • Put Extra Cash to Work. If you have too much cash set aside, market declines are an excellent opportunity to take advantage of better bargains. The sooner you can get your money working for you, the better, and there is no better time than when the market is on sale.
  • Rebalance periodically.  Once you determine an appropriate investment mix between stocks and bonds or other asset classes, make sure you review your portfolio at least annually to ensure those allocations are in balance.  For example, stocks have performed well over the past few years, and you might be too heavy in stocks, and therefore taking on more risk than you intended.  As a result, this is an excellent time to reduce them to your intended target allocation and add to bonds.  Rebalancing is the ultimate “buy low and sell high” strategy.  But, again, discipline is critical because it is not easy reducing stocks when they are climbing and then adding to bonds.

Bottom Line

We know stocks produce some of the best long-term returns in our long journey to building a suitable nest egg.  History shows this to be the case dating back to the 1920s.  But, despite their popularity and appeal, we know stocks go through unexpected bouts of turbulence and sometimes worse.

Yet, suppose you have a game plan and appropriate investment allocation for your situation.  In that case, you must keep in mind that periodic market declines are normal and necessary for stocks to continue climbing higher.  So, sit back, try to relax, follow your game plan and maybe even take advantage of some of the opportunities this situation creates.


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