Seeing the prototype of your portfolio can be alarming, but sometimes it may be necessary. There are ways to deal with stock market corrections and overcome them.
Frequency of Market Correction Incidents
The S&P 500 index has recorded 54 instances of market corrections and bear markets since 1928. The longest market correction lasted for 929 days between March 2000 and October 2002. In 2020, the COVID-19 pandemic disrupted the stock market, leading it into another bear market. However, within five months, the S&P 500 regained all of its value and recorded new highs.
How to Endure in the Event of a Market Correction
Anticipating a correction can be stressful. First, you must resist the urge to “time the market.” Although you can gain some short-term profits from trading market waves, strategies like periodic trading rarely work for building long-term wealth.
Data shows that most people are not disciplined enough to stick to a winning investment style during market corrections; instead, they tend to trade at the wrong times, causing even greater losses. Professional financial planners rely on science rather than behavioral biases when building portfolios.
When creating an investment portfolio, it is expected that you will have negative returns in half of the annual quarters. We can help manage the extent of negative returns by identifying a mix of investments that either have greater potential for appreciation or have lower potential for high returns as well as reduced risks—this process is called “diversification.”
Note: If you plan to invest in the market, it is best to understand that corrections happen frequently, and it often pays to ride them out.
Controlling the Severity of Corrections
You can control the severity of the corrections you may face by carefully choosing the mix of investments you hold.
Understand the level of risk associated with investing. For example, in high-stakes investments, there is a possibility of losing all your money. With slightly lower risk, you might see a decline in the range of 30% to 50%, but you will not lose it all. This is a significant difference in risk.
Next, you must understand how to blend these different investments to reduce the risks across your entire portfolio.
Note: It is essential to reduce exposure to significant market corrections as you approach retirement. Upon retirement, you should organize your investments so that you do not have to sell market-linked investments during market corrections. Instead, you can use the safer portion of your portfolio to support spending needs during those periods.
Learn about the relationship between return and risk in investing. The opportunity for high returns always comes with additional risks. The faster and higher stock prices rise, the less likely high returns are in the future.
In the timeframe following a stock market correction or bear market, the opportunity for high future returns in the market increases. In 2017, cryptocurrency became a craze. It achieved returns exceeding 1000% that year, and retail investors specialized in getting into it, while professional traders avoided it.
Note: It is important to understand that when prices rise this much, they will ultimately face a significant correction.
Finally, if you do not wish to face the possibility of experiencing a market correction, it is best to avoid investing in the stock market altogether. Instead, invest in safer investments. However, there is an opportunity cost in safe investments—you may miss out on preparing yourself for the future life you envision for yourself and your family. The key is to find a good balance.
Questions
Repeated
What is periodic trading? Periodic trading is when you buy and hold a stock for at least one day and for a period of up to several weeks. The goal is to achieve short- to medium-term gains. This contrasts with day trading, where positions are held for less than one day in the stock market. Both approaches require time and carry risks. If you are investing for the long term, you typically want to buy and maintain a diversified portfolio of stocks and other assets.
What is diversification? Diversification is a risk management strategy. It involves having a variety of investments in your portfolio. Diversification can include different types of assets, such as mutual funds, stocks, bonds, and exchange-traded funds (ETFs). Diversification may also involve diversifying within each type of asset. For example, you can purchase mutual funds that focus on different sectors or companies of varying sizes. You may also diversify by acquiring foreign investments as well as domestic ones.
The Balance does not provide tax, investment, or financial advice. The information is provided without regard to the investment objectives, risk tolerance, or financial circumstances of any specific investor and may not be suitable for all investors. Past performance is not indicative of future results. Investing involves risks, including the risk of loss of the original capital.
Source: https://www.thebalancemoney.com/how-to-handle-stock-market-corrections-2388309
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