In late January, we experienced a market correction. A market correction is defined by a decline of 10% from the most recent peak. That said, we’ve already seen a small rebound. As of the writing of this post, the S&P 500 is down just over 6% for the year. So what should we make of this correction? A few thoughts...
This is normal. We should expect this to happen. Market corrections (again, double digit declines) have occurred in almost two-thirds of all calendar years. It’s easy to forget that this is to be expected when markets are performing well. I’m not trying to dismiss the fact that drawdowns are hard on investors. It’s a tough pill to swallow, which is why the best investors are the ones that don’t panic or overreact.
This could be an opportunity. If you are a young investor, or have some investments that aren’t needed for near-term cash flow, this can be a great time to make contributions. We’ve all heard the age old adage “buy low, sell high.” If you are fortunate enough to have some cash built up, a market correction is often a great time to buy in.
If we take a look at the S&P 500 over the past 50 years, we can see that it has continued trending up over time but not every time. If you believe, like I do, that 5, 10, or even 15 years from now, that the market will be higher than today, then doing some extra buying-in during corrections is a sound strategy.
Buy low doesn’t mean buy lowest. Investing is hard. We just talked about buying low. The next question clients often have is, “But what if the market drops another 5-10% or more?” It’s possible that you’ll buy-in and see some additional pullback before an eventual rise. That’s part of investing. No one can accurately predict the bottom. When we see opportunities, it’s smart to take them but that doesn’t mean that it’ll be a smooth ride. Buy low, sell high is doable. Buy lowest and sell highest is impossible.
Tracking goals is key. Market corrections like the one we just experienced is another reason why we believe in goals-based investing. If a client has a long-term goal of buying a lake house in 20 years and a short-term goal of funding a child’s wedding in the next 3, that client should invest differently for each goal. If you invest in one portfolio for all goals and a short-term correction happens, then you may need to exacerbate the issue by pulling money from a falling portfolio. If you invested more conservatively for the short-term goal, the market correction doesn’t have the same sting.
Investing is not financial planning. Many people conflate investing with financial planning. These are two very different practices. With holistic financial planning, it’s much easier to make lemonade out of lemons because you have the 30,000 foot view and understand how everything works together. An example would be tax-loss harvesting during a market correction, resulting in saving yourself future tax dollars. Or maybe you have the majority of your wealth in pre tax retirement accounts and a market correction makes converting some of that wealth into Roth status more advantageous. Without a holistic view, it’s very difficult to make these decisions in a timely manner and understand what ripple effects will come from them.
There will always be noise. There will always be something that can convince you that it’s time to pull the plug on investing. That’s just how it is. Last month it was a market correction. Next month it may be rising rates, inflation, etc. Financial media want shock and awe like any other form of media, it brings in the eyeballs. That’s why the focus will always be doom and gloom. Buying low and buying often, holding, and rebalancing a portfolio isn’t sexy, but it works. Tune out the noise.
Keep the long view in sight. Focus on your goals and what needs to be done to achieve them. Market corrections are temporary but knee-jerk reactions to them can have longstanding consequences.
Post written by Nick Vail, CFP®