The Dow Jones Industrial Average (^DJI 0.67%), which is composed of the stocks of 30 U.S.-based multinational giants from a variety of industries, is full of flaws. To begin with, the index is price-weighted instead of being weighted by market cap, like the broad-based S&P 500 (^GSPC 0.87%). That means companies like Goldman Sachs have more weight than Apple because of the former's higher share price, which makes little sense. There's also the issue of not all sectors being included in the Dow; real estate and utilities, for example, have no representation.
Nevertheless, the 121-year-old Dow Jones Industrial Average remains an iconic index that Wall Street and investors follow closely. Generally speaking, as goes the Dow, so goes investor sentiment.
Image source: Getty Images.
How much do you really remember about the Dow's "plunges" in 2017?
Throughout the year, investor sentiment has been regularly challenged. In March, the Dow tumbled up to 238 points in a session. In May, the iconic index slipped 373 points in a single session. And more recently, in August and September, the Dow dipped by 274 and 234 points, respectively, in one day. On a purely nominal basis (i.e., just looking at point value), these are pretty notable moves. If you read a headline that says the Dow closed down by more than 200 points, it's liable to catch your attention.
But do you really remember the Dow's so-called plunges during the year? My guess is that you probably don't, and I'll tell you why: It's because the market tends to trend higher over the long run. Each and every one of these terrible days for optimistic investors was wiped away by a bull-market rally within a matter of days or weeks. In fact, the Dow closed at a fresh all-time high last week.
Erasing poor single-day performances is Wall Street's specialty
However, this isn't just a 2017 trend -- it's been going on for a really long time. Ed Yardeni, the founder and President of Yardeni Research, aggregated stock market correction data on the S&P 500 since Jan. 1, 1950, which led to a number of interesting findings.
Since the beginning of 1950, there have been 35 corrections in the S&P 500 totaling at least 10% when rounded to the nearest whole number. In each and every instance, the aggregate drop in the index -- be it the minimum 10% or the 57% it tumbled during the Great Recession -- was completely retraced (and then some) by a bull-market rally. Often these rallies took just weeks or months to erase moves lower, although a few steeper corrections took years. Nonetheless, staying the course over the long term proved optimistic investors correct, time and again.
Image source: Getty Images.
Furthermore, it becomes apparent from the data that the stock market has been in rally mode approximately three times as many days since 1950 as it's been correcting or in a bear market. The data very clearly suggests that buying and holding for long periods of time gives you the best chance to grow your wealth.
A separate report from J.P. Morgan Asset Management confirms this by showing that trying to time the market almost certainly won't work over the long run. In the 5,000-plus-day period between Jan. 3, 1995, and Dec. 31, 2014, six of the S&P 500's best days came within two weeks of its 10 worst days. Good luck trying to pinpoint what those days will be ahead of time!
Worried about a correction? Stick with dividend stocks and/or ETFs
The long-term trend clearly shows that patience is a virtue for long-term investors. But what if that still doesn't calm your nerves about a correction? After all, the data shows that corrections occur about once every two years, and we haven't seen a sizable correction in more than half a decade.
If this keeps you up at night, there are two great solutions: Pack your portfolio with dividend-paying stocks, and consider adding exchange-traded funds (ETFs).
Dividend-paying stocks have a number of advantages beside the fact that companies are sharing a percentage of their profits with shareholders, which helps you to hedge against the inevitable downside that occurs during a correction. Dividends can also act as a beacon to draw income-seeking investors to companies with time-tested business models. A company is unlikely to continue sharing a percentage of its profits with investors if it doesn't expect to remain healthfully profitable.
Image source: Getty Images.
Many dividend-paying stocks also allow investors to set up dividend reinvestment plans, or DRIPs. A DRIP allows investors to purchase more shares of dividend-paying stock with their payout, oftentimes without a commission. Setting up a DRIP allows your share count and dividend payouts to compound over time, quickly building your wealth.
Aside from adding income stocks to your portfolio, consider diversifying through an ETF. ETFs have the liquidity of a stock, but the funds themselves often hold dozens, hundreds, or even thousands of stocks, meaning a problem with a single company isn't going to doom your investment. You can utilize ETFs to focus on specific sectors, certain sized companies (e.g., small-cap, large-cap), or just diversify across the broader market.
For example, the Schwab U.S. Large-Cap Growth ETF (SCHG 0.95%) has 426 large-cap growth stocks in its portfolio across a variety of industries. The management style is considered passive, so you won't see a lot of turnover, which means the expenses ratio to run it is a minuscule 0.04% a year. With interest rates remaining relatively low, growth stocks seem poised to continue outperforming value, making the Schwab U.S. Large-Cap Growth ETF worth a look for cautious investors.
Regardless of what you do decide on, stick with those investments for long periods of time and add to your holdings with regularity to reduce your chances of feeling the sting during a stock market correction.
