How To Deal With A Stock Market Correction – Forbes Advisor

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Stock market corrections—a broad decline in major market indexes of 10% or more—are unavoidable facts of life for investors. In fact, one occurs on average about once every two years.

At the outset of the Covid-19 pandemic, we endured one of the deepest and quickest corrections in history (some might call it a crash, but both terms would be accurate). The S&P 500 lost 30% in a matter of weeks—and then regained it all inside of five months.

The Covid Correction offers a key lesson: When stocks go through a correction, avoid overcorrecting. Panic moves only lock in losses and forfeit future gains. Just over 12 months after the bottom of the Covid Correction, the S&P 500 doubled in value. Investors who ran for cover probably missed out on some or even all of those gains.

But during the heat of a correction, it can be almost impossible to stay cool and collected. Here’s a guide to keeping your sanity and your money during a stock market correction, when it feels like everyone around you is losing theirs.

The First Rule of Corrections: Get Perspective!

It’s normal to be nervous when a stock market correction arrives. But the first rule to follow during any correction is to get some perspective on what’s happening.

There have been 28 corrections in the S&P 500 since World War II, with an average decline in the index of about 14%. The market has always recovered and returned to new all-time highs—sometimes within a few months, sometimes in a few years.

Let’s look at some worst-case scenarios. Wall Street pros call a drop of 10% to 20% a correction, and typically refer to anything worse than that as a crash or a bear market. These labels aren’t set in stone, and they hardly matter much when you see your portfolio covered in red.

During the dark days of the Great Recession of 2007 to 2009, investors lost more than half their money as the housing bubble burst and global markets melted down. Outside of a global pandemic, it’s hard to imagine a more frightening time for markets.

Investors who suffered through the worst of the Great Recession did have to be patient to get their money back—but if they held on, they got it back. The S&P 500 hit its recession bottom in early 2009. By early 2013, the index was right back at all-time highs.

Avoid the News, Don’t Talk Stocks with Friends

Hate to say it, but news programs that follow markets minute by minute are not very helpful when you are trying to keep perspective. How much you lost or gained today will never inform sound decision making, warns Liz Weston, author of financial books like “Deal With Your Debt.”

“Once a correction happens, limit your exposure to news about it and avoid checking your balances,” says Weston. “Fear can trigger impulsive reactions, like selling into a downturn and locking in your losses.” Remember: If you haven’t sold it, you haven’t lost it.

This coping strategy might also mean you want to avoid hanging out with market-obsessed friends, too. This is a good time to take a break from constant chatter about Wall Street.

When a Market Correction Gets Hot, Stay Cool

You’ve spent a lot of time making a financial plan. You’ve read the blogs, perhaps worked with a professional, and you’ve made the best decisions you could. Now is the moment to be confident in your strategy and stick with it. Don’t change directions just because a correction is blowing your way.

Behavioral scientists talk about hot and cold cognition. Cold cognition involves formulating ideas and making rational choices based on facts. But when we are agitated, hot cognition kicks in and our emotions rule the day.

One trick to success in a correction is to recognize when you enter a state of hot cognition. That’s the moment you need to stop acting and trust the decisions you made when you were cold.

Consider Making Minor Adjustments During a Correction

There’s no reason you can’t reevaluate your old choices based on new information during a stock market correction. Maybe you really believed in technology stocks five years ago when you built your portfolio, but now you are starting to think they are too risky or government regulators are about to change the profit equation for the industry.

Never let a crisis go to waste, and a market downturn could be an occasion to reexamine and adjust your plans. That’s cold ideation in action, and it’s quite different from an emotional impulse to sell because of a bad day in the stock market.

Corrections can be a good time to examine your overall investment strategy and consider rebalancing your portfolio. Maybe one investment held up well as the others fell, and now it’s an outsized part of your portfolio.

Just don’t make your move at 3:45 p.m. ET after watching another late-afternoon market selloff. Sketch out a new plan with a pencil and paper on Saturday morning at your local coffee shop instead.

Your Correction Superpower: Dollar Cost Averaging

Seeing markets fall day after day can really get inside your head, but don’t let them. Most critically, don’t be tempted to sit on the sidelines with your available cash. The thing about stock market corrections is that you never know when they might turn around—and studies show that missing out on a big market turnaround can be a portfolio killer.

Research from J.P Morgan finds that investors who missed the top 10 trading days during a recent 20-year stretch would’ve seen their returns fall by almost half, compared to those who stayed invested the whole time. When did those top 10 days happen? Often after some of the worst trading days, in the depths of a correction.

Never try to time the markets—this advice can’t be repeated often enough. That also means It’s impossible to time when a stock market correction might turn around. All this makes dollar cost averaging your best friend during a market correction—even if you already implement the strategy with regular contributions to a workplace 401(k) plan.

“If you’re dollar cost averaging into a retirement plan or another account, keep going—buying in a downturn essentially means you’re buying stocks on sale,” says Weston.

Nearing Retirement? Don’t Panic.

Market corrections shouldn’t alarm long-term investors who are decades away from retirement. You’ll have forgotten the downturn by the time you need the money that you are socking away in your retirement plan, after all.

But investors who are close to retirement might have something to worry about. Workers who planned to retire in 2008 or 2009 really suffered from bad luck. Or was it luck? Trying to squeeze every last dollar out of investments right before you need the money—to retire, to buy a home, to pay for college—is a losing proposition.

Ideally, soon-to-be-retirees should be planning for their cash needs years in advance. They should slowly be exchanging risky investments for safe ones when it makes sense, well before retirement. If this describes your retirement planning process, don’t let the correction derail you.

Like portfolio balancing, a stock market correction could be the right time to re-evaluate your retirement plan. Hanging up your spurs during a market correction or bear market is a risky choice. Perhaps you should consider working a couple of more years, rather than diving into full retirement. The longer your investments stay in the market, the more time compounding has to work its magic.

Forget the Regret

So maybe this all sounds good to you—but still, you’re losing money! Right now! Look at all that red! At a time like this, it’s hard to resist the urge to do something.

Take that energy and put it into researching your next five or 10 years. Whatever has happened has already happened. You can’t fix a market mistake after the fact; it’s a sunk cost.

Now is the time to take all that regret and turn it into something useful. Don’t overcorrect by pulling the trigger on trades inspired by today’s bad news. If you are 35, talk to 45-year-old you and make a plan for her. Make an appointment to talk with a financial advisor. Read some investment books and devour all of the resources you can.

The goal is to avoid having to feel any regret the next time a correction arrives. Because even as this one is ending, the clock is already ticking on the next one.

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