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Investors: Prepare for stock corrections

Stock market sell-offs of 10% are neither unusual nor predictable. In a Money Talk Video, Paige Radke talks with Kyle Tetting about how long-term investors can ready themselves for the inevitable. Their conversation was part of the 2021 Investment Outlook Seminar. A transcript follows.

Kyle Tetting: Paige, we get no shortage of questions about market corrections, certainly a thing that is on many investors’ minds. I think it’s important maybe to have a working definition of what a correction exactly is. Can you tell us a bit more?

Paige Radke: So, a market correction is anytime you have a downward movement from the most recent high of 10% or more. Now if you go above 20%, that’s when you start entering the bear market territory.

Kyle: Let’s focus on corrections here for just a minute. They’re not exactly a rare occurrence, right?

Paige: No, not at all. Market corrections are actually very common and a normal and healthy feature of market dynamics. Since 1980, there have been about 37 corrections, with an average of about 13% for each one of those.

Kyle: And so, as we look at those market corrections, we have an idea of what average looks like. I guess the other question of course is what kinds of things lead to market corrections?

Paige: When it comes to what triggers a market correction, it can be pretty much anything. It could be a small shock to the supply chain. It can be concerns of inflation. It can be even something that we might not even recognize. It could just be market trades and market movements.

But the important thing to remember is that they oftentimes are very short-lived, and it’s important to just remember that even though the market has gone down, it’s not necessarily a bad thing for investors.

Kyle: I think that’s part of what makes corrections so common is that they do have any number of causes. Of course, the other question here is what we tell investors to do when it comes to preparing for a market correction, what to do once we’re in a correction. Any tips?

Paige: So the number one thing to keep in mind when it comes to preparing for a correction is like we said: It’s very difficult to predict. And so what you have to do is always have in mind what your portfolio should look like, what level of risk you’re able to stomach. And frequent rebalancing is going to be what keeps you there.

The other thing that you want to do is make sure that you have diversified assets within your portfolio. You have to remember that not all assets are going to react the same when the market does go down. When the stock market has been doing really well, I think it’s easy for investors to try to move away from the bond allocations in their accounts, but you have to remember that those bonds are the things that give you the courage to hold the stocks when the market is going down.

Kyle: So of course, we have now prepared for the correction, but as we know, they’re going to come. They are inevitable. And so now we’re in a correction. What should investors be thinking about doing with their portfolio?

Paige: Once you enter a correction, the most important thing to do is not panic. Panic leads to overselling, and it just becomes a self-fulfilling prophecy, which will just cause the market to go down further. Other than that, as long as you’ve been rebalancing your portfolio, keeping it within your risk tolerance, the only other thing that I can suggest is looking for some other things that you could do to take advantage of that market. Think tax loss harvesting. If you have big distributions that you have to take, it might be better to take them out at those lower asset values and let it ride up then in one of your more taxable accounts

Kyle: And can’t stress enough that market corrections create opportunity, right? Opportunity for some of the things you talked about but also opportunity potentially to put your foot back on the gas.

Paige: Exactly. So if you have been taking money out of the market, or if you were sort of waiting for that entry point, as you had concerns about a possible correction on the way, that’s the time to actually start buying rather than to start selling.

And the same goes for the actual mutual fund managers within your account. They also have some cash on hand, and when you see a correction, it gives them those entry points that are a little bit more appealing, that they can then also ride up.

Kyle: Thank you so much, Paige.

Paige: Thank you.

Paige Radke is an investment advisor at Landaas & Company.

Kyle Tetting is research director and investment advisor at Landaas & Company.

Learn more
Retirees: How to handle stock sell-offs, a Money Talk Video with Dave Sandstrom
5 ways rebalancing calms anxious investors, a Money Talk Video with Marc Amateis
Mind correlation to control risk, a Money Talk Video with Paige Radke
The case for active funds amid volatility, a Money Talk Video with Kyle Tetting
2021 Investment Outlook Seminar, a Money Talk Video
(initially posted November 24, 2021)

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