Evidence Points to Staying Pat During Market Corrections

William J. (Bill) Lynott |

CHICAGO — Why do so many of us do it? Perhaps it’s because our brains are hard-wired, telling us to run when we sense danger. Whatever the reason, when the stock market goes into a serious correction and prices fall, many investors tend to panic. Their brains seem to send them an urgent message declaring that it’s time to sell.

Conversely, when things are humming on Wall Street and prices are hovering at their highs, those same investors can’t wait to get in on the action.

The result for those investors (some experts tell us, most investors) is the costly mistake of selling low and buying high.

That, of course, is the precise opposite of the path followed by the most successful investors: buying low and selling high.

While it’s true that pulling out of a bear market when prices are dropping can appear to benefit your investment portfolio by limiting the short-term damage, it can also cause missing out in the inevitable rebound that follows a big drop by failing to get back in the market soon enough. Being out of the market—even for a short time—during a major rebound can result in the loss of considerable wealth-building profits.

So what should you do during a market correction? Perhaps, say many financial professionals, nothing.

Often, the wisest thing to do during periods of extreme market volatility is to stick with the investment plan that you've already devised,” says Bill McNabb, Vanguard Fund’s chairman and chief executive officer. “Equity markets have reaped sizable gains over the past six years. Such setbacks, while unnerving, are inevitable."

Such a do-nothing approach might be a tough path to follow when you’re frightened by sharp unrealized losses in your investment portfolio, but turning those unrealized losses into real losses by selling out can be exactly the worse thing to do. McNabb points out that no action is actually an active decision, and can be the right decision for reaching your long-term financial goals.

And McNabb is not alone in his feelings.

“When the markets are rising strongly, says Certified Financial Analyst Charles Rotblut, “investors are more likely to put money into stocks (buying high). When a steep market correction or a bear market occurs, many investors move to sell their stocks (selling low). Then, once the market has rebounded and recorded significant gains, those same investors notice the profits they are missing out on and they decide that it’s time to put money back into stocks (buying high). This repetitive cycle results in a process of locking in big losses and missing out on big gains.”

While most financial professionals recommend that you sit tight during major market corrections, there are those (including Warren Buffett, often cited as the world’s most successful stock market investor) who say that such a time is a rare opportunity to build your wealth by buying stocks.

Not every investor will have the stomach to buy more stocks when prices are falling, even though history tells us that Buffett is correct in his belief. For those of us who find that even a do-nothing approach can be unnerving when stocks are taking a nose-dive, here are some things we can do to help settle our nerves:

REMIND YOURSELF: STOCK MARKET CORRECTIONS ARE COMMON AND INEVITABLE

The long history of equity investing is peppered with major and minor corrections. In less than 100 years, starting with the major market crash of 1929 to the real estate “bubble” crash of 2008, to the recent Chinese economy correction starting in June 2015, there have been no less than a dozen significant market corrections. Every one of those has been followed by rebounds that led to new market highs, except for the most recent that hasn’t yet had the time to follow suit.

Clearly, history is on the side of those who say stick to your own investment plan by sitting tight during a market correction. Of course, it’s important that you have a plan of your own, including a well-diversified portfolio, in order to benefit fully.

DON’T LET EMOTION GET THE BEST OF YOU

Constant checking of stock prices during a market decline, coupled with exposure to doomsayer’s market predictions, is sure to rattle you more than it should. When emotions dominate our decision-making process, good judgment is certain to suffer.

Successful investors have learned that they must make a special effort to prevent emotions from unduly influencing investment decisions, particularly sell decisions. Perhaps the best way to accomplish this is to break the habit of agonizing over daily fluctuations in market prices.

MAKE MARKET VOLATILITY WORK FOR YOU

Once you come to terms with the fact that market volatility and periodic market corrections are inevitable and normal, it’s time to put that knowledge to work for you and not against you.

Continue to invest on a regular and planned basis, regardless of fluctuations in market prices. In order to put market volatility to work for you, it’s important to participate in an automatic investment plan such as an IRA or 401(k), a target date mutual fund, or some variation of your own plan for regular investing.

Remember: The more you invest when market prices are down, the more you will benefit when prices rebound.

While there is no guaranteed formula for optimum success in managing your investment portfolio during market downturns, the evidence strongly suggests that the best plan of action for most investors is a plan of inaction.

Information in this article is provided for educational and reference purposes only. It is not intended to provide specific advice or individual recommendations. Consult an accountant or tax adviser for advice regarding your particular situation.

About the author

William J. (Bill) Lynott

Freelance Writer

William J. Lynott is a veteran freelance writer specializing in business management as well as personal and business finance.

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