FINANCIAL TOOL
Market Correction
A market correction is defined by a drop of between 10% and 20% from the most recent high point.
While these don’t happen every year, we don’t often see two years pass without experiencing this kind of drop.
It’s important to recognize that 10%+ drops in the market are usually just a correction. But they always feel far more important than that because of the convincing logic the media conveys for why things will fall further.
Of course, some do turn into bear markets.
But here’s why it’s important to know the difference.
Since 1987, the average correction has taken about 155 days to find its trough and turn around.
The average bear market, on the other hand, has tended to last about twice as long, approaching 10 months, before reversing course.
It’s important to remember that average doesn’t mean normal. Corrections and bear markets can last significantly longer or shorter than the average in real time. But averages are useful when thinking long-term.
For short- and intermediate-term investors (think 1-10 year time horizon) bear markets matter more than for long-term investors.
Because bull markets tend to be far longer in duration and greater in magnitude, long-term investors often face the bigger risk of missing out on the recovery than of riding through the remaining downside.
But for those with shorter term goals, such as what I teach in the courses on budgeting and investing, bear markets can be a greater risk to reaching these goals on time.
When a bear market is identified in its early stages (not usually before), the magnitude of impact can potentially be lessened through the use of a variety of methods such as:
1.) Option collar
2.) Protective put options (though these become more expensive with higher volatility)
3.) Buffered ETFs
4.) Greater bond exposure
5.) For the stock allocation, an overweight toward large-cap, defensive value stocks (e.g. consumer staples, healthcare, utilities)
Each individual’s situation will differ based on their personal goals, time horizon and aversion to risk. But at the end of the day, corrections are a normal part of any bull market, and betting on them turning into bear markets is usually betting against the odds.