Compared to full-blown bear markets, they're minor annoyances. Nevertheless, market corrections take a monetary -- and therefore mental -- toll on investors. It feels right to try to defend your portfolio from these slight setbacks.
But, should you actually attempt to do so? And if so, how?
Market corrections are common, and usually brief
First things first. What constitutes a market correction? There's no official definition. Broadly speaking though, a pullback of 10% (or more) from an index's peak is considered to be a correction For the sake of comparison, most consider a slide of 20% or more to be a bear market.
A 10% sell-off, however, is a lot in light of the fact that the stock market's average annual gain is also on the order of 10%.
What's glossed over by that average yearly return is how starkly inconsistent the years being averaged are. Sometimes stocks rally 30% in a 12-month stretch. Sometimes they lose 20%. And sometimes they may end a year close to where they started it.
Even when stocks are in the midst of a major long-term rally though, they certainly don't move upwards in a straight line. Zigzags are the norm regardless of the bigger-picture trend. A report from Yardeni Research points out that since the bull market that began back in 2009, the S&P 500 (^GSPC -0.11%) has suffered six distinct corrections that didn't turn into bear markets. A similar look back by brokerage outfit Charles Schwab tells the same story in a different way, noting that true corrections take shape once every couple of years.
In every case thus far, the U.S. market has recovered and then gone on to reach new highs above the pre-correction peak.
In other words, assuming those historical patterns will keep repeating, you can confidently ride out any short-term setback. They always eventually reverse course ... usually within a few months.
Too much trading can cut into your returns
It's natural to want to capture all of the market's broad upside while steering clear of the bulk of its downside. At times, it may feel as though if we paid close enough attention, we'd have the ability to navigate the stock market's every twist and turn. In reality, though, we don't.
Numbers from Standard & Poor's put the matter in an alarming light. Its regularly updated report card on the performance of actively managed mutual funds -- funds more likely to frequently buy and sell than buy and hold -- indicates that in 2022, 51% of them underperformed the S&P 500.
And that was a relatively good year for these actively managed funds. The results worsen the more you stretch the time frame. For the past five years, more than 86% of these funds are trailing the benchmark index. For the past 10 years, over 91% of them are lagging it.
Just as an example, consider the exchange-traded funds managed by Wall Street fave Cathie Wood at her firm, Ark Invest. Several of those actively managed funds, such as the Ark Innovation ETF and the Ark Next Generation Internet ETF, were all the rage -- and outperforming impressively -- when the market was roaring in 2020 and 2021. Since then though, both of them have severely underperformed the broad market as well as their most relevant benchmarks.
Those poor performances may have something to do with the fact that these funds' holdings are being regularly swapped out, perhaps at the worst possible times. The Next Generation Internet ETF's turnover during its most recent fiscal year was 76%, meaning a little over three-fourths of its positions were established just within the prior 12 months. That's a lot of trading. The Ark Innovation fund's annualized turnover rate was lower, but still relatively high at 55%.
Connect the dots. It's difficult to truly know when the broad market's or an individual stock's peaks and valleys are taking shape. Even most professional stock-pickers can't do it.
Doing nothing is a viable strategy
So what's the sermon being preached here? The one that seems like it's being preached: You can't control or predict market corrections. You can control what you do about them though. And what you should do about them is absolutely nothing other than add more quality stocks to your portfolio.
That's admittedly easier said than done. As was noted, it often feels like we have a firm grasp on what lies immediately ahead for stocks. We don't though -- not really.
The market's near-term and even intermediate-term behaviors are ultimately driven by emotions like fear or greed rather than the economy or business fundamentals. Emotions, however, can be tricky to figure out as well as quick to change. Don't even bother trying. Instead, do what you know you can do, and have faith that keeping your long-term focus on the fundamentals will pay off in the end.
