U.S. stocks recently rebounded well after going through a correction in October, although several commodities are yet to bounce back. A stock market correction is defined as a time when major stock indexes fall at least 10 percent from a recent high.
Some investors find themselves stuck in a nasty emotional cycle caused by fear of losing money when stock prices head south.
However, those that gear up their portfolio for occasional corrections are generally better able to avoid making rush, poorly planned investment decisions. So what should you do during a market downturn to avoid losing money?
Review Your Portfolio
The first thing you need to do is access your portfolio. All investments involve risk, but you can take a few steps to protect your portfolio from a market meltdown. Have you invested in just a few skyrocketing stocks? Have you only invested in stocks or ETFs? Understand the process of asset allocation in which investors mix various types of investments to minimize the risk to their portfolio as a whole.
If you are to invest in the stock market during a downturn, you must realize that determining the amount you allocate towards bonds, stocks, and other market areas is a crucial, if not the most important decision. The allocation you select is well aligned with your tolerance for risk and is based on more than just what you expect your return will be.
One of the best ways to short risk in a correction is to buy an ETF that rises when the underlying stock index it tracks falls. ETFs, or exchange-traded funds, are traded on stock exchanges like the Nasdaq and NYSE just like stocks. However, an ETF tracks a basket of securities, bonds, an index, or a commodity, unlike a stock which focuses on one company.
Investing in ETFs often minimizes the risks associated with owning stocks of individual companies, since an investor can get involved with an entire industry or index with just a single investment. Investors can also short individual stocks as well if they want more direct exposure and feel they have an edge.
Small-cap stocks in the tech and biotech sectors often get hammered the most in a downturn because they are valued based on speculative terminal values. They are high beta stocks with weak balance sheets and yet to report a profit.
Investors ought to be patient and should not be carried away by emotions when making their investment decisions. Don’t be quick to buy during a market correction, instead, hold tight and keep up to date with what is happening in the financial world. Before putting more money to work, it best to wait until markets begin to show signs of stability.
Congress may pass laws, the Federal Reserve may hike or lower rates, and large firms may experience difficulties. In short, there are plenty of things that can affect you and your money, which is why you need to stay informed.
Look Forward to Better Days
Investors are never certain when a stock market correction will start, when it will end, what will cause it, or how catastrophic it will be. However, the stock market does not remain in a correction for long. In most cases, it takes just four months to break even after a drop of 10 percent.
There have been two massive bear market situations in the past two decades – a fall of 56 percent from 2007 to 2009 and a fall of 49 percent from 2000 to 2002. The stock market experienced almost ten correction situations during that period. However, stocks still went up nearly 331 percent.
The markets returned an average of 7.58 percent right before the dot-com bubble of 1997 to January 2017. Although that is a little below the 10 percent lifetime market average, your money could have doubled every 10 years, which is really good.
Each stock market correction is different from the other, but some follow patterns. Corrections create scary times for investors, nonetheless, it is important to remember that they are a normal part of an economic cycle.
When stock markets start getting into five or more years without tumbling, investors start bracing for it. In the long run, markets will offer a fair return for the risk taken. But investors have to be disciplined both in their approach to reviewing portfolios as well as in their willingness to stay invested for them to earn that return.