Correction: No, not something that is done to correct a mistake. I’m referring to a stock market correction. Since one is currently going on it seemed likely a timely subject.
Corrections
A correction is when an Index, such as the S&P 500 Index, falls 10% – 20% from its latest high, over a few weeks or even months. This can even happen to the share price of your favourite company. Corrections are quite normal and can last a few weeks to a few months while the market consolidates before it resumes moving higher. A drop of more than 20% from its record closing high is considered a bear market.
While a correction occurs over weeks or months, when the market undergoes a surprising and sudden drop of 20+% in one or two days it is often referred to as crash. A high-speed correction, if you will. One of the leading contributors to a stock market crash is emotions, such as panic and fear. When there is uncertainty in the market and the share prices start to suddenly go down, fear and panic can set in, and investors start selling their shares in an attempt to preserve cash.
A market crash is what happened at the onset of the Covid-19 pandemic. It was a big gulp moment when I checked the portfolios and saw they each were down between 20% – 30%. I was tempted to sell but realized there was nothing I could do, other than lock in losses.
More recently, the Nasdaq Index went through a correction in January as it fell over 12% from its mid-November, all time high. When an Index falls, that means it underlying companies have seen their respective share prices fall, some more than others. Unfortunately for me, all three portfolios include several Nasdaq listed companies, so each Portfolio went through its own correction. Some worse than others. ☹
Causes
Corrections are usually caused by one of two things. The first thing is bad news, especially if its unexpected. Current examples of sources of potentially bad news include: the ongoing impact of Covid-19; concerns of high inflation leading to higher interest rates; and the current tensions between NATO countries and Russia over Ukraine. The other primary cause of a correction is when stock prices climb to high, too quickly and get well ahead of their underlying value. People believe the price will rise indefinitely, until it doesn’t. And then the share price ‘corrects’.
What to do
When a correction or crash occurs, I take a breather from investing. I remind myself there have been numerous corrections and the markets have always recovered and gone on to establish new all-time highs. I’ve learned to stay calm and keep my emotions in check.
As you can see in the chart below, over the last 10 years all four Indexes have had their ups and downs put have always gone higher. Even after the Covid-19 market crash in March 2020 all four Indexes have gone on to establish new all-time highs. You can also see why I went big into the technology companies which largely reside on the Nasdaq exchange. 😊
During this recent correction I’ve taken the opportunity to reassess the portfolios to ensure they are meeting their objectives. In the case of Portfolio 1, I’m leaning towards getting out of some of the higher risk, small cap companies because they tend to fall the hardest and are among the last to start moving upward. Portfolio 2 is weathering this downturn fine. There are one or two companies I’m considering selling but I’m in no rush to sell them. Portfolio 3 is too concentrated in one particular stock but that is largely because the share price has gone up so much relative to the other companies in the portfolio. As problems go, this isn’t the worst one to have.
As for buying and selling stocks, hopefully you have not invested any money into the stock market that you anticipate needing in the next year or two. If you did, there is nothing you can do but hope for a quick recovery before you need the money. Unless you absolutely need the cash, what you should not do is sell your shares as all that will do is lock in a loss and/or cause you to miss out on the gains when the market starts heading up again.
If you don’t have any cash to invest, resist the urge to do something. In this case, the best thing to do is do nothing. The market eventually starts heading upward and you want to be invested to catch the gains from the up lift.
While a drop of up to 10% or more appears scary, it does present buying opportunities since stocks are ‘on sale’. However, you need to have the stomach, the right mindset, and available cash, to invest in stocks during a falling market. This would be the classic ‘buy low’.
if you’ve got investing cash set aside for a market drawdown, take advantage of the ‘sale’ and strategically deploy your cash. Consider purchasing additional shares in your highest conviction companies you already own (think of this as dollar cost averaging) or make an initial purchase in a company that you are confident will ride out the storm and will outperform when the market rises. You will probably miss out on the exact market bottom (don’t try to time the market), but you don’t want to miss out on the market turnaround. While getting the maximum discount would be great, getting a 10% – 25% discount on great companies can really boost a portfolio.
I know what you’re thinking – why not simply sell your stock when the market first starts to fall and buy back in when it starts heading back up. This would be market timing and rarely works since no one can predict what will happen in the future and what the market will do. What typically happens is you sell your stocks and get back in after the market has returned to its previous levels. More often than not, investors get back in at higher prices so all they’ve done is cost themselves transaction fees and potential tax implications. I know, I tried this with the Ethereum cryptocurrency, and so far, its an unforced error and has not worked out so well.
Remember, while stocks can fall quickly, most stocks go up more than they go down. During a correction the best thing you can do is stick to your investment plan and don’t let panic cause you to make decisions you’ll regret.