Keeping Perspective - When the Market Falls

In early March the U.S. stock market dropped 10% from the all-time high. When the market drops by 10% or more it is considered a market correction. Investing during a correction can be tough as no one likes to see their account balances decline. Once stocks start going down, it feels that momentum will continue to push them lower.

What we need to understand is that this is very normal. On average, the market has a 10% drop every 20 months. Yet, every time it happens, we start to wonder if the world is beginning to unravel.

Since 1980, the U.S. stock market, which we will define as the S&P 500, a collection of the 500 largest U.S. companies, has experienced an intra-year decline of about 14% in the average year. Despite that, stocks have returned almost 12% annually since 1980. In other words, the market recovers rather quickly in most years from periodic declines.

As of April 10, the U.S. stock market is down nearly 15% from its all-time high. For most investors the biggest fear is that the market continues to fall significantly in value. While that’s possible, history indicates it’s not likely. In the last 75 years there have only been 13 years when the market dropped by 20% or more.

So, what should you do as the market loses value? The best answer is to buy more stocks. When our favorite items at the grocery store go on sale, we buy more. The same goes for the stock market. When prices are at a discount, investors should take advantage.

The chart below shows returns for the 12-month period after the stock market falls into correction territory. As you can see, in all but one year since 2008, the market produced significant gains within a year from when it hit correction territory.

But should you invest more heavily in stocks now?

If you are more than 15 years from retirement, your portfolio should already be mostly allocated to stocks. A drop in the market now will not jeopardize your retirement savings. You have decades until the money is needed, which is more than enough time for markets to recover. If you have retirement savings not in stocks, buying stocks as they drop is an unquestionably smart move.

If you are nearing retirement, your portfolio should already be more diversified with a portion of your savings in less volatile investments, such as bonds. While the stock market has tumbled this year, bonds have increased in value by almost 3%. A fully diversified portfolio of 60% stocks and 40% bonds has declined by less than 5% this year. However, if you have too much allocated to cash and bonds, say more than 50% of your portfolio, it could be a good time to begin purchasing stocks in small increments.

No one knows whether this pullback will be short-lived or is the beginning of a bigger downturn. Based on history, the stock market recovers from downturns rather quickly, but perhaps this time is different. Again, no one knows.

Just keep in mind, regardless of your age, if you have a properly allocated investment account, there is nothing wrong with sitting on your hands and doing nothing. In fact, that’s often the best course of action.