With the stock market’s historic growth that began after the recession in early 2009, many experts believe a 10% pullback would be a healthy sign for the markets going forward. This sort of drop is not horribly painful, especially by historical standards, and in order for the stock market to keep advancing there must be at least a risk of decline.
Why is a market correction healthy and beneficial? After all, most people are counting on continued gains to be able to meet their goals. The main reason is that it prevents a stock bubble from forming. Bubbles occur when stock prices rise so far that they are clearly out of line with the earnings potential, and value, of the underlying companies. We saw the consequence of that in the awful 2000-02 and 2008-09 market wipeouts, when some people lost half their wealth or more.
Certainly, market corrections never feel healthy when they occur. It seems people only think it’s a healthy correction when it is other investor’s holdings that are affected. People get fearful as the market declines, the media fan the flames by giving investors reason after reason to be afraid, and worries that this is the beginning of the next crash begin to develop.
While many investors admit that a 5% pullback is manageably unpleasant, concerns expand when the market decline hits 10%. That’s what customarily constitutes a correction. In the most recent sell-off, at the beginning of this year from January 26th to February 8th of 2018, the S&P 500 index fell 10.2%. The market barley crept into correction territory, but then rebounded and went on to have several days of all-time highs later in the year.
In a great post at awealthofcommonsense.com, Ben Carlson looked at the S&P data going back to 1950, and found 28 time periods when stocks fell by 10% or more. So, on average, the market has experienced an official correction every 2.25 years.
S&P Losses of 10% or More Since 1950
- Total Occurrences: 28 Times
- Average Loss: -21.6%
- Median Loss: -16.5%
- Average Length: 7.8 Months
- Greater Than 20% Loss: 9 Times
- Greater Than 30% Loss: 5 Times
As you can see, the average post-1950 market correction lasted just under eight months and the median total loss was 16.5%. But what about steeper declines?
Out of the 28 times the S&P 500 decreased by 10%, the market went on to decline by 20% – the standard definition of a bear market – only nine times (32% of the time), and a loss greater than 30% only five times (18%). The data confirm that, although these types of large losses do occur, they really are the exception.
Here are the past 12 corrections in the S&P 500 Index, according to Standard & Poor’s:
Can you Stomach a Correction?
Are you thinking: “I don’t think I can stomach a drop of 16.5%.” Then that’s where the wisdom of diversification and having a financial plan becomes apparent. Remember that the data above represents the historical performance of the S&P 500, an index composed of 100% stocks.
Working with a capable financial advisor can help ensure you have an asset allocation mix of stocks, bonds and cash that reflects your tolerance for risk. A riskier portfolio tilted more heavily towards stocks will perform worse than a conservatively balanced one if you panic and sell when the market declines.
Even for a younger investor, your portfolio likely shouldn’t consist of 100% stocks. The appropriate allocation for an average investor in their 30s or 40s might be closer to 80% stocks. This means that your portfolio should suffer a drop of around 13.2% during the median market downturn. If that number still makes you queasy, consider having a conversation with your advisor about the amount of volatility you are comfortable enduring within your portfolio.
By making adjustments to your plan: boosting savings, changing goals, or altering time horizons; you should be able to construct an asset allocation that allows you to rest easier during these periods of market turbulence.
Although the recent market pullback might create anxiety, media headlines and possibly fear, remember this: we’ve been here before.-source for market data included in this article: “When Stocks Fell 10%…” Ben Carlson. https://awealthofcommonsense.com/2018/10/when-stocks-fell-10/