Stock market corrections are scary, but you can't let them ruin your retirement plan. Rather than letting panic influence your important financial decisions, now's a great time to embrace a balanced approach to volatility and long-term growth.
The smartest move right now is to embrace some time-tested principles based on your personal goals and time horizon.
Corrections and long-term performance
It's important to understand what corrections are, and how they have typically worked. Most investors define a correction as a 10% to 20% drop in stock market value. It turns into a bear market beyond 20%. Market pullbacks tend to be sudden and steep, and it's easy to feel panic. But investors should understand that these are relatively common events, and they're only temporary.
Since 1946, there have been nearly 30 corrections that exceeded 10%. An additional 12 crashes pushed the S&P 500 beyond a 20% loss. Every time, the market bounced back. Those recoveries were probably more rapid than most people realize.
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Historically, it only takes an average of four months for the market to recover from a correction. Bear markets that erased between 20% and 40% of the stock market's value were fully reversed in 14 months, on average. Even the steepest crashes generally climb back into positive territory within five to 10 years.
There were three serious downturns since the beginning of this century, and market indexes were still at all-time highs last year. Corporate profits tend to reflect global economic growth, and stock prices tend to reflect corporate profits over the long term.
The playbook for younger investors
In the stock market, we can confidently predict long-term growth, but it's punctuated by rough patches that last anywhere from a few months to a decade. Investors in their 20s, 30s, or 40s are probably more than a decade away from retirement. If you aren't taking distributions from your 401(k) or IRA, then any gains or losses in that account are unrealized for now. Today's volatility doesn't really matter for these accounts, but the long-term returns are extremely important.
Younger investors should basically ignore short-term volatility as it pertains to their retirement plans. If you have a 20-year time horizon, then growth should be the priority. Periodic volatility is natural, and these temporary losses aren't being locked in.
The market has plenty of time to recover, as it has in every recorded case throughout history. You should keep buying stocks in your retirement accounts -- they're basically on sale right now. Embrace the newfound discounts.
The playbook for investors nearing retirement
Things are a bit more complicated if you're only 10 to 15 years away from retiring. You'll probably need to make withdrawals from retirement accounts in your first few years of retirement to pay for healthcare and other basic needs. Even if you aren't withdrawing from those accounts, you'll probably be rebalancing portfolios by selling stocks and buying bonds.
You want to avoid selling investments that are temporarily down, thereby locking in losses. That's why volatility management is so important for investors in their 50s or above. If this correction turns into a bear market or full-blown crash, it could take years just to break even again. Loading up too heavily on growth stocks and other volatile assets could cause big losses, and you might not have enough time to recover.
This doesn't mean that it's time to panic and sell everything. Instead, review your personal risk profile and quantify risk tolerance. Figure out what your optimal portfolio allocation looks like, and make sure that you have the right balance of growth stocks, value stocks, dividend stocks, bonds, and cash. It's important to retain some exposure to the growth that will come over the next 20 to 30 years, but you want to shield a portion of your hard-earned nest egg from volatility.
