Stock market corrections are natural occurrences in which the market prices of securities decline, usually following a period of growth. It is usually estimated that such corrections occur about once per year, varying in their magnitude. However, unlike bear markets – periods of time in which the markets are steadily declining – market corrections rarely last long, usually persisting for around one quarter of a year or less.
When confronted with the question of how to best handle market corrections, many new investors are left without a good answer. For many, the primary response is to try and trade in line with the markets. As such, during a period of recession, many investors’ first instincts are to sell their shares and get out of the market before their portfolios lose too much money. However, research has shown that more often than not, this kind of plan actually ends up hurting investors’ portfolios further, because they end up selling their shares when the market is down and not realizing gains when it bounces back up.
Instead, a better way to shield your portfolio from market corrections might be to start by expecting that corrections will occur periodically. By adopting this kind of mentality, investors can position themselves to better handle market corrections when they do occur. Further, by expecting that corrections will occur from time to time, investors will more likely avoid the natural panic that occurs when their share prices begin to decrease suddenly.
Then, after understanding that market corrections are a normal occurrence because of market volatility, investors can begin to think about how to better structure their portfolios. To do this, the first thing that investors should understand is the risk level associated with each of their existing investments (if they have any) – or their own risk profiles if they are new to investing. To do this, investors should also assess the total level of risk that they would ideallyincorporate into their portfolios. Keep in mind that this assessment process should include an understanding of risk versus return – namely, that a higher level of risk could yield higher potential returns than lower-risk options.
Finally, with an understanding of the riskiness of the stocks in your existing portfolio – or, for new investors, an understanding of the kind of risk you would like to have – you can begin to work on your asset allocation and diversification strategies. Essentially, owning a variety of assets is one of the best ways to prepare your portfolio for market corrections, because specific industries or kinds of securities may “correct” in different ways than others. For example, if you owned only technology stocks and the tech industry was the first area to correct, your portfolio might fare worse than it would if you owned a variety of different stocks. Thus, by expecting market corrections and making risk diversification moves before a correction occurs, you can put your portfolio in a better position to weather any potential downturns.
All in all, there is no perfect way to handle market corrections, but by understanding your portfolio now and expecting corrections at some point during your investing career, you can put yourself in a better and more confident place!