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The Raffer Investment Group

7 Concepts to Remember About Stock Market Corrections

7 Concepts to Remember About Stock Market Corrections

By Jeremy Raffer

 

I’m not going to tell you a stock market correction is a pleasant experience. Watching the value of your hard earned money and investment portfolio plummet can create quite the nauseous pit in your stomach. Emotions run rampant. You wonder if it will ever stop and how you're supposed to recover.

I’m here to remind you that a stock market correction is a normal occurrence and has happened before. So let's look at 7 important concepts to remember about stock market corrections:

 

Table of Contents

1) History

2) Recovery

3) Diversification

4) Strategy

5) Perspective

6) Timing

7) Taxes

Summary

 

 

1. Stock Market History

In any given year, a stock market correction is considered a normal occurrence and is defined as a 10% pullback from a recent peak. According to the market analytics firm Yardeni Research, from 1962 to 2013 we’ve had one roughly every 2 years. This pattern will likely continue over time and has been a recurring aspect of a normal and healthy market.

Stock market crash

 

2. Stock Market Recovery

According to the data analytics company Factset, during the five years after a market correction the average return from the S&P 500 Index was 10.26%. This is slightly greater than the average return for the same investment during the total 40 year data set which was 9.90%. This illustrates that market corrections are not going to permanently decimate your ability to take vacations and enjoy retirement. More often than not they are actually followed by more favorable markets.

 

3. Investment Diversification

We recommend a diversified investment strategy. This means instead of owning individual stocks or the S&P 500 Index, you get exposure to a variety of asset classes including small and foreign. When you have multiple asset classes in your investment strategy you typically have exposure to Mid Cap, Small Cap, International Developed, and International Emerging. Historically, these asset classes have outperformed domestic Large-Cap stocks. Diversification can help to blunt the losses during a correction and magnify the recovery afterwards.

 

diversification

 

4. Rebalancing Strategy

Most people use an investment strategy that is emotional—meaning they hold onto the positions that have done well and eliminate the ones that do poorly. We believe that eventually all things revert back to the mean; this is the tendency of both good and bad performing investments to normalize over time as well as the market to overreact. To take advantage of this, we recommend rebalancing your portfolio following a major market correction. Following a correction, a rebalance can really set you up for success when the market finally normalizes.

 

5. Take a Long-term Investment Perspective

Stock market corrections can only hurt you if you have a very short-term perspective. Traders experience a drag in performance when they have issues with margin calls (your funds dropping below minimum requirements) and increased trading costs. The types of clients we work with typically have long-term time horizons which are perfectly capable of weathering these type of events . A longer time horizon has historically been the most profitable long term investment strategy to maintain, and is better for your heart and health.

 

6. Downside Market Protection

People typically think that the time to generate all their returns is when the markets are hot, but this couldn’t be further from the truth. In reality, it’s more important to protect against the down than to participate fully in the up. For example, let's say you have $1 and you lose 20%. You now have $0.80. Most people think that if you gain 20% you’ve got your dollar back but that’s not true; you’d need to gain 25% to break even--because you’re working with a smaller amount--the 80 cents. What this means for an investor is that if you can trade some of the downside away, you don’t have to focus as much on performance when things are good.

downside market protection

7. Taxes - Tax-loss Harvesting

Market corrections can create losses which can be realized and used to offset income which would result in tax. Assume an investment you own is at a loss. You can realize that loss and use it to offset gains infinitely, and income up to $3,000 per year. Also, you don’t have to risk missing out if the market recovers after you sell. This strategy is called tax loss harvesting.

 

Summary

In summary stock market corrections hurt but create opportunities. Unfortunately, they are pretty much unavoidable. These strategies and concepts are helpful to remember when you have a tough hand dealt to you and want to play it well.

Learn more about our Invesment and Asset Management services.

 

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Jeremy Raffer, MBA
Wealth Manager
 
Phone – 201-773-4641
 
 
 

Any opinions are those of Jeremy Raffer and not necessarily those of Raymond James. Information has been obtained from sources considered reliable, but we do not guarantee that the material presented is accurate or that it provides a complete description of the securities, markets or developments mentioned. 

The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. Past performance does not guarantee future results.

All hypothetical scenarios are for illustrative uses only. There is no assurance that any investment strategy will be successful. Investing involves risk and investors may incur a profit or a loss. Prior to making an investment decision, please consult with your financial advisor about your individual situation.