As others have said before, volatility is the price of admission in the stock market, and the last few years have been a good reminder of that. After a steady bull market that lasted 11 years, stocks plunged when the coronavirus pandemic started, before rallying for nearly two years on near-zero interest rates, government stimulus, and a boom in sectors like tech and real estate.
That bull market peaked in late 2021, giving way as rising inflation sparked rising interest rates, spooking investors and launching a bear market that started early in 2022. In 2023, stocks partially bounced back on encouraging signs of resilience in the economy and hopes about the potential for artificial intelligence to increase efficiencies in multiple industries.
After all that volatility, many investors still operate as if we're in a bear market (because we are). Even the recent gains in the stock market are just a bear market rally.
Indeed, the Nasdaq Composite and the S&P 500 recently entered a correction, defined as a decline of more than a 10% decline from a recent peak, though the two indexes exited the correction just as quickly. Still, that movement is a reminder that stock market corrections can happen suddenly.
While you can't predict market corrections or control them, you can control how you react to them. Here are a few strategies for handling market corrections and other sell-offs.
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Keep some dry powder on hand
For most stocks, periodic sell-offs are the norm. So it makes sense to have some cash on hand for when stocks go on sale.
You may want to develop a system where you put a certain percentage of your allocated cash into the market for every 10% that a benchmark index like the S&P 500 falls. For example, you could invest 10% of that cash when the index falls 10%, another 20% if it falls 20%, 30% when it's down 30%, and 40% when it falls 40%.
Or you could front-weight your investments more and invest 25% of your cash for each 10% the stock market falls. Alternatively, you could forget about the 40% sell-off and just say you're going invest a third for each 10% step-down stocks take. With this approach, you would have invested all of your cash by the time stocks fall 30%, but it's very rare for the market to fall 40% or more.
Having a plan for a market correction will not only help you take advantage of the sell-off but also make you more composed when one happens. Additionally, you could apply a similar strategy for when individual stocks fall as well.
Don't panic-sell
The worst thing you can do in a market correction or a bear market is to panic-sell your stocks because you're afraid of a market crash. The problem with the strategy is that even if you're right about stocks crashing, you'll never know when to buy back into the market.
Even famed investor Warren Buffett has said that timing the market consistently is impossible. Market bottoms seem easy to spot in the past when you look at a stock chart, but it's much more difficult to do so in real-time, especially when you're dealing with the emotions of watching your portfolio lose value.
Focus on the long term
It's good to be a buy-and-hold investor, but buying and forgetting is generally a bad approach to investing. Instead, it makes sense to buy and continually verify that your investing thesis still holds up.
That's a good thing to remember in market crashes. It's also worth remembering that the S&P 500 experiences a correction on average less than every two years. In other words, it makes sense to be mentally prepared for them, but it's also worth remembering that the S&P 500 has gained 9% on average annually (with dividends reinvested). While volatility is part of investing, you'll eventually be a winner just by owning an index fund and tracking the S&P 500 if you stay in the market long enough.
