Last week was one of the more unsettling weeks in a long time for investors. The Chinese stock market hit bear market territory, the Greek debt saga continued to confound the world, and to top it off the largest stock exchange in the U.S. was completely shut down for almost four hours on Wednesday.
With all of these headlines rattling the market, I believe that now is a good time to revisit a topic I wrote about back at the end of 2013, the importance of market corrections.
Corrections are a common, important, and even embedded feature of the stock market. They act as a natural circuit breaker for the market, and a mechanism to curb excessive speculation (not that it always works). They occur along with or in anticipation of bad news like a slowing economy, recession, political turmoil, or even full-scale bubbles like the housing bubble in 2006.
I’ve done research backing up to 1928 looking at the historical market data to find the average timeline for corrections. On average, the stock market corrects 5% every 10 weeks, 10% every 33 weeks, and 20% (also considered a true bear market) every two and a half years.
Currently, we’re 35 weeks out from a 5% correction, 190 weeks out from a 10% correction, and 320 weeks out from a 20% correction. As you can clearly see, averages are good for a rule of thumb, but they don’t always tell the whole story.
While it looks like we might be due for a correction, we shouldn’t fear it. I recommend that investors remember three things when a correction hits:
- Corrections are normal. The stock market doesn't go straight up forever. We're going to see some downward movement. Think of the market like a clock's pendulum – it has to swing both ways.
- Now is not the time to panic. I always suggest that investors keep a balanced, well-diversified portfolio, and it's so in times of corrections you have some protection. You have to trust your original investment strategy when the market gets rough.
- It could be an opportunity. A correcting market offers lower priced entry points. This is an especially good opportunity for younger investors who are planning to be in the market for an extended period of time.
Bottom Line
The first half of 2015 has clearly been a volatile and frustrating period, with both stock and bond markets relatively flat for the year, and headlines out of Greece and China effectively putting a cap on the market for now. Ultimately, though, today's market moves are a great reminder of why a balanced portfolio between risky and safe assets is key.
Certified financial planner Wes Moss offers financial and accessible investment advice to Atlanta Bargain Hunter readers.
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