The Importance of Corrections

As the Dow Jones hovers near an all-time high, investors are getting nervous.

One of the most common questions we’ve been getting lately is, “When is the next correction coming?” So we went back to a research study from this past summer and updated it considering the markets latest run north.

Corrections – widely agreed to be drops of 10 percent over a given period of time – are an important, embedded feature of the stock market.  We went back to 1928 and looked at historical market data to find out how often (on average) “corrections” happen.  Here are the numbers:  The market undergoes a five percent correction about every 10 weeks, and a 10 percent correction every 33 weeks.  (A true bear market with a drop of 20 percent or more occurs about once every two and a half years) – again these periods of time are “on average.”

These events should be respected, but not feared.

Think of a correction as circuit breaker.  They usually occur when a hot market gets hit with worrisome news – a slower economy, weak sales data, turmoil overseas.  Such events cause the market to pause and fall back as institutional and individual investors reassess their positions based on the new information.  Such respites are good for the market.  You can’t run a high performance car at 7000 RPM for too long without blowing the engine.

This market (as of Nov. 29) has been remarkably strong in 2013…and now up almost 27 percent on the year without a five percent correction since June.

So how far “past due” are we for any sort of a correction (historically speaking)?

  • Five percent corrections happen on average every 10 weeks.

Where are we today? 22.5 weeks.

  • 10 percent corrections happen on average every 32 weeks (more than once a year on average).

Where are we today?  109 weeks or about 2.1 years.

  • 20 percent corrections happen on average every 127 weeks (about every 2.5 years on average).

Where are we today? 239 weeks or about 4.75 years.

So, what does this mean for most investors wondering how they should invest their 401k plans at work?

  1. Remember corrections are normal.  The stock market does not go straight up forever…without turbulence.  We have gone a long time by historical standards without a pull back.  So next time you hear that the Dow is down on the evening news remember that corrections are a normal part of the process.
  2. Rebalance today.  Because the stock market has gone up for so long without a correction and is hovering near an all-time high – don’t forget about some of the other options you have in your 401k plan or investment accounts.  If you are near retirement, make sure you have at least a portion of your investments in more stable areas ie short term bonds and stable-value accounts.  Rebalancing from risky to less risky areas allows you to maintain a balance that you can live with.
  3. Keep in mind TIME.  If you are 40 or 50, you have 20 or 25 years before retirement.  Then once you are in retirement, you will likely have another two or three decades your money needs to last.  So understand that the decisions you make today have implications for decades.  This means, stay diligent about saving (20 percent if you can each year), and always maintain — at least 50 percent for most investors — in US and International stocks/mutual Funds/ETFs overtime.

In summary, know that there will be bumps in the road ahead.  Stay balanced, stay the course, and keep reminding yourself that consistency wins the race.

 



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