Sometimes stock prices drop across the entire market at once triggered by a range of things, such as a natural disaster, political turmoil, concerns over rising interest rates, a global health crisis, or problems within a single sector that cause a domino effect across the market.
A decline in stock prices of 10% from their most recent high is called a market correction. Long-term investors experience many of them over the course of their lives. So, if you’re investing for retirement or another long-term financial goal, you need to know how to weather a market correction without being blown off track.
The common definition of a market correction is a drop in average stock prices of at least 10% and less than 20% from the recent peak. Once prices return to the most recent high, the market is said to have “recovered” from the correction.
A drop in prices of at least 5% and less than 10% is known as a pullback or dip. And drop of 20% or more is a crash. On average, crashes take longer to recover from than corrections do.
For example, between 1950 and 2022, market corrections in the S&P 500 took between 13 and 531 days to hit their lowest point and begin to recover, with the average correction lasting around 126 days. Crashes of 20% or more, on the other hand, took anywhere from 33 to 929 days to bottom out, with the average crash lasting 391 days.
Investors can’t know for certain that a correction isn’t a crash until it’s over. If stock prices drop by 14%, the trend could reverse course from there and return the market to its previous peak. On the other hand, prices could continue to fall, eventually dropping by 20% from recent highs, resulting in a crash.
Market corrections don’t occur on a regular cycle and are not easy to predict. That means predicting a correction and pulling your money out of the market just before prices drop isn’t a feasible strategy.
Historically, the best thing to do during a correction has been to sit tight and ride it out. That’s because corrections have always been followed by recoveries. And you can only benefit from the recovery if you hold onto your investments. If instead you panic and sell, you’ll lock in your losses.
Keeping cool as you watch the value of your investments drop is easier said than done. It can be helpful to tune out the endless market coverage if needed. You may want to speak with your financial advisor who can help put the market correction into historical perspective and keep your focus on your long-term investment goals.
Corrections can provide helpful insight into changes you may wish to make to your portfolio. If seeing your assets go into the red triggers debilitating anxiety, you might have a lower risk tolerance than you originally believed. Your financial advisor can help you reassess your asset allocation and potentially tweak it to better fit your needs.
Market corrections are an unavoidable fact of long-term investing, and a sound financial plan takes them into account. If you’ve already got an investment plan that reflects your unique situation, then the best thing to do during a market correction, based on the historical performance of the stock market, is to remain committed to your plan.