Odds are if you’re an investor, you’ve experienced market corrections along your journey. Market corrections are classified as a drop in 10% or more from the asset class highs. For example, the S&P 500, the index for large-cap U.S stocks, experiences a correction on average once per year according to Deutsche Bank. Naturally, you’d think investors would eventually become accustomed to the regular occurrence of corrections. Unfortunately, oftentimes that’s not the case. Emotional reactions to corrections can derail an investor’s long-term strategy and set them back years in their ability to achieve financial independence. This article will explore 6 tips to managing a market correction to ensure you stay on track with your long-term investment strategy!
1. A History Lesson
As I mentioned, corrections in the market are a fairly common occurrence. Looking back through history we can see that they occur roughly once per year. Yet, even when the market has a pullback of 10% or more, more often than not, it’s ended the year with a positive return.
What this graphic tells us is, as long-term investors, shouldn’t we be using these declines in the market to put more cash to work? Corrections are a great time for long-term investors to “buy-in” at a discount and reap the long-term rewards.
It’s natural to have an emotional reaction to seeing your investments lose value. Especially during sudden, dramatic corrections in the market. However, that doesn’t mean we have to react to that emotion. Even when it seems SOMETHING has to be done to stop the bleeding.
The best thing we can do as investors is reflect on our emotions and have the self-awareness that we KNEW a market correction would eventually happen. Ideally, having planned ahead of time how we would handle the correction.
In the absence of emotional reactions comes logical reasoning. And from a logical standpoint selling our investments that we’ve set aside for the LONG-TERM is not the answer during a market correction. We know it’s impossible to consistently predict when the market will hit its bottom or its peak. Therefore, selling our investments and potentially missing the impending rise in the market would ultimately hamper our long-term investment strategy.
3. Focus On What You Can Control
Investors don’t control headlines. We don’t control company earnings. We don’t control interest rates or trade agreements.
What we do control is our asset allocation, our ability to contribute to long-term investments, and our reactions to corrections. Once these fundamental principles are accepted, it makes it easier to manage our long-term investments.
A 30-year-old has 30 years until retirement or until they’re eligible to withdraw from their retirement accounts without a tax penalty, should have an understanding that the short-term market fluctuations don’t matter! The asset allocation and savings rate into the retirement account do. With 30+ years to invest, they can afford to weather the short-term corrections that occur in the market in order to take advantage of the long-term growth and compounding that will occur with their investments. Year over year, they should focus on increasing their savings rate to coincide with their compensation increase or increase in lifestyle expenses.
4. Ignore the Financial Media
The financial media is always looking for an attention-grabbing headline. They prosper on investor fears and anytime a negative headline comes out, it’s oftentimes exaggerated. Headlines are typically focused on the short term. Market “gurus” are always trying to predict the next asset bubble or market collapse and they’ve unsuccessfully been able to do so since 2008.
With that in mind, information that impacts your long-term strategy shouldn’t be ignored. We know that interest rates have been rising for quite some time and that the FED plans on continuing to do so. Therefore, long-term investors probably aren’t buying up massive amounts of long-term bonds. As interest rates rise, the prices of long-term bonds are negatively affected more so than short-term bonds.
Information that can affect your long-term asset allocation or potentially a “tactical” strategy in your investment portfolio should be reviewed and acted upon from a logical standpoint. Again, removing the emotion from the equation is key.
5. Tax-Loss Harvesting
An actual strategy that can be applied during market corrections is tax-loss harvesting. A well-diversified portfolio will likely have losses in particular asset classes during any given year, especially in the midst of a 10% market decline. It can be advantageous from a tax planning perspective to sell the security with a loss and use that loss to offset capital gains. Ultimately reducing your overall tax liability. Any losses not used to offset capital gains during the year are carried over indefinitely after the first $3,000 are used to reduce your ordinary income. Therefore you can use them in the impending years when the market and your investments have large gains!
The key with tax-loss harvesting is to ensure you don’t buy back the security or a similar security within 31 days. Doing so will enact the “wash-sale” rule, negating the tax loss benefits that you’ve “captured”. Instead, wait 32 days and re-purchase the security if it’s still a key part of your long-term asset allocation.
The Bottom Line
When it comes to managing market volatility and in particular, market corrections the key things to remember are: keeping your emotions in check, maintaining a long-term outlook if it’s a long-term investment portfolio, focusing on what you can control, and using any losses to help offset your tax liability in future years. Corrections can be used to our advantage as long-term investors if handled in this way!
If you need help designing a long-term asset allocation, want to discuss market corrections, or build a financial plan that puts you on track towards financial independence, schedule a free consultation today!