A game plan for market corrections

It pays to keep perspective during market corrections.

  • Investing Strategies
  • Investing Strategies
  • Investing Strategies
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Key takeaways

  • Given the inevitability of market pullbacks, it's important to have an investment plan you can stick with through market ups and downs.
  • Active investors should think about exit strategies during market volatility.

After setting new highs in September, the S&P 500® Index of large-cap US stocks has fallen roughly 10%. While there is no official definition, a drop of 10% from market highs is generally considered a correction.

The sell-off seems to be driven by concerns that earnings growth, while strong, may be peaking, that rates may continue to go higher, and that economic growth has been slowing in China and other parts of the world.

So with a correction at hand, it may be time to brush up on what corrections have typically looked like, and what you may want to consider.

How long and deep will this correction be?

Of course, no one can predict the timing or depth of a stock market correction with certainty. What we do know is that they have historically been a normal part of investing. In fact, since 1920, the S&P 500 has on average experienced a 5% pullback 3 times a year, a 10% correction once a year, and a 20% bear market decline every 3 years. So, while it may be unsettling, it’s not unusual to experience a sell-off of this magnitude.

One thing that is worth remembering is that the market typically recovers pretty quickly from correction. The chart below shows the largest drop from a market high in each year (blue dot). You can see that it’s not uncommon to have significant market declines. But the market still usually recovers and produces positive results for the year (shown as the bars).

What it means for investors

Long-term investors: Stick to your plan

If you are saving for retirement or another goal that is years away, the time to consider how much of a loss you can handle isn’t during a correction. Rather, you should consider the appropriate risk level for your portfolio when you are looking at your long-term goals, and thinking clearly about your financial situation and emotional reaction to risk.

If you haven’t created a plan, you should. If you have one, it may be worth checking in to see if your investments are still in line with that plan and if your plan continues to reflect your investment horizon, financial situation, and risk tolerance. If all that is so, you will likely be in a better position to manage the ups and downs of the market. If your mix of investments is off track, consider rebalancing back to a more neutral positioning.

Active investors: Be ready

While most investors who have a long-term plan probably don't need to make any portfolio changes in anticipation of a spike in market volatility, some more-active investors may want to take action to prepare for more volatility. That could mean anything from setting exit strategies on existing positions, using stop loss orders, or tracking technical indicators for signs it could be time to sell.

More-active investors might also want to consider having a cash reserve, and creating a watch list of stocks to consider buying at certain price points, to prepare for buying stocks during the downturn.

Some Fidelity portfolio managers have been finding opportunities in energy, utilities, and biotech. (Read the story: Finding opportunities in volatile markets.)

Retirees: Manage your income

For retirees, who may be relying on their investment portfolio for a portion of their income, a market drop can present a different kind of challenge. Hopefully, retirees have an income plan that is built to withstand different market conditions. If so, you really won’t need to react to a short-term market move. If not, it may be a good time to sit down with an advisor to discuss you strategy.

The bottom line

For the second time this year, the market has entered correction territory. While we don’t know if this will be short-lived or the beginning of a bigger downturn, history shows that the market recovers from corrections, and most sound investment strategies are built to withstand volatility. As a result, long-term investors should make sure they are sticking with their plan, and not taking on any hidden risk.

Next steps to consider

Research Fidelity's managed accounts.

Explore ways to reach your goals.

Make sure your portfolio is in line with your plans.

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