For nearly 10 years now, the stock market has been practically unstoppable. Both the 122-year-old Dow Jones Industrial Average (^DJI 0.06%) and broad-based S&P 500 (^GSPC -0.22%) had quadrupled earlier this year from their March 2009 lows. Meanwhile, the technology- and biotech-heavy Nasdaq Composite (^IXIC -0.52%) had more than quintupled since bottoming out nearly 10 years ago. Investors who've held throughout a couple of hiccups since then have been handsomely rewarded.
However, the past seven-plus weeks have been challenging for investors. Since hitting their all-time highs, the Dow Jones is approaching correction territory with a decline of more than 9%; the S&P 500 has hit correction territory with a drop of 10.2% from its all-time intraday high; and the Nasdaq Composite has been blasted, with losses of 15% since hitting its peak.
Clearly, investors are worried. But should they be? Here are 11 stock market correction facts you need to know.
Image source: Getty Images.
1. Market corrections are more common than you realize
The first thing you should be aware of is that corrections -- i.e., declines of 10% or more from a recent high -- are far more common than you probably know. Since the start of 1950, the S&P 500 has undergone 37 corrections of at least 10%, and it's had quite a few other dips in the high single-digit percent range, according to data from market analytics firm Yardeni Research. That's one correction less than every two years. And while the stock market doesn't exactly adhere to averages, it nevertheless demonstrates just how common declines are.
2. We'll never be able to pinpoint when they'll occur
Despite being so common, corrections are impossible to predict -- at least over the long run. According to an analysis from JPMorgan Asset Management, if an investor were to have held an S&P 500 index fund between Jan. 1, 1995 and Dec. 31, 2014, they'd have netted a cumulative return of 555%, or 9.9% a year. Mind you, this includes holding through both the dot-com bubble and the Great Recession. But, had they missed just the 10-best trading days over this 20-year period because they'd scurried to the sidelines out of fear, their aggregate return would have been more than halved to 191%.
3. We also have no clue how steep of a decline corrections will bring
Not only are corrections impossible to predict, but we can never be certain how steep the decline will be with one. Over the past 31 years, only two corrections in the S&P 500 have officially hit bear market territory (i.e., a 20% decline), with the drop in 1990 coming within a tenth of 1% of this line in the sand. On average, investors will endure a bear market about once a decade, but, to be crystal clear, they were far more common prior to the 1990s. The rise of the internet has eased retail investors' access to information, thereby lessening volatility to some extent.
Image source: Getty Images.
4. We'll never know what causes a correction until after the fact
Truth be told, we're never going to know ahead of time why a stock market correction occurs. Recently, I labeled 25 reasons the stock market could crash, and while one or more could very well be responsible for this current slide, an X factor could just as easily come out of nowhere to stun Wall Street and investors. Only after a correction hits does it become clear what caused it.
5. They tend to be short-lived
No one likes seeing red in their investment portfolios, but there is some decent news about stock market corrections -- namely, that they tend to be short-lived. Taking into account the previous 36 corrections in the S&P 500, 22 of them lasted 104 or fewer days. Comparatively, just seven persisted for longer than a year. Only two times since 1992 has a correction lasted longer than 10 months: the dot-com bubble and the Great Recession.
6. They're usually emotion-driven
Regardless of the reason for a correction, you can almost count on emotional investors and short-term traders driving volatility. It's uncommon to see a lot of volatility when stocks are rising, but it's very common when momentum picks up to the downside, especially with corrections historically being a short-term event.
Image source: Getty Images.
7. Using margin during a correction isn't a good idea
Because the downside moves in corrections can be so swift and violent, it's generally never a good idea to use margin while investing (i.e., borrowing money from your brokerage to increase your leverage). Although there are some instances where margin may make sense, such as in short selling, margin can be an especially dangerous tool in a volatile environment. Your best course of action is to invest only what you're willing to lose, and that means leaving margin alone.
8. Only short-term traders tend to be impacted
Another important but oft-overlooked aspect of stock market corrections is that they don't actually hurt long-term investors. That's because long-term investors aren't going to head to the sidelines when a 10% drop, or greater, occurs. The only group of folks who really pay during corrections are the emotionally driven short-term traders.
9. They're a great time to reassess your holdings
To be perfectly clear, any time is a good time to reassess your investment holdings. However, a stock market correction offers a nice kick in the behind to do so. When evaluating your stock holdings, what you're primarily doing is determining if the reason(s) you purchased a stock in the first place still holds true. If your investment thesis hasn't changed, then there's probably no reason to sell.
Image source: Getty Images.
10. Dividend and value stocks tend to outperform
If you're interested in seeking out stocks that tend to outperform in a downtrending market, consider dividend and/or value stocks. Dividend stocks usually have time-tested, profitable business models that aren't going to be impacted too severely by an economic slowdown. Plus, the dividend you receive helps to partially offset any near-term paper losses.
Meanwhile, value stocks could come into focus as interest rates rise and growth stocks deflate. Let's not forget that value stocks have actually run circles around growth stocks over the past 90 years.
11. Long-term investing always wins out
Finally, but most importantly, understand that time is your friend. Despite 36 previous corrections in the S&P 500, all 36 were completely erased by a bull market rally. Although the stock market offers no guarantees, that's as close to one as you'll get with investing. And in many instances, these corrections were put in the rearview mirror within months, rather than years. This suggests that investors who buy high-quality stocks and hang onto them over the long run have a very high probability of success.
