On Thursday, March 13, the S&P 500 (^GSPC 0.21%) finished 10.1% below the all-time high it touched on Feb. 19, marking a rapid sell-off that sent the index into correction territory. As of March 13, the tech-heavy Nasdaq Composite (^IXIC +0.01%) had already been in a correction for several days.
A correction is defined as a decline of 10% or more from an index's recent high, while a bear market is a prolonged period where an index is down by 20% or more from its peak.
Here's what to expect as the broader market continues to be volatile.
Image source: Getty Images.
Navigating stock market corrections
In general, after any given correction, the market is more likely to recover than it is to enter a bear market. In fact, we already saw the S&P 500 cross back out of correction territory on Friday with a 2.1% gain (it was trading about 7.5% below all-time highs as of Monday afternoon).
According to a Reuters' analysis of data from Yardeni Research, there were 56 corrections between 1929 and 2024, and 22 of those -- or 39.3% -- deepened into bear markets.
Recently, though, bear markets have become rarer. Since 2010, there have been 10 corrections -- including the one that began on Thursday. But only two of those turned into bear markets -- the pandemic-induced sell-off in 2020 and what we now call the 2022 bear market. So while corrections have been unusually frequent in the last 15 years, a below-average number of them turned into bear markets. But in every case, buying the dip produced monster results for long-term investors.
For example, the last correction came in October 2023, as the market digested a rapid recovery after the 2022 sell-off and an artificial intelligence (AI) rally. However, that correction proved transient: The S&P 500 gained more than 20% in 2023 and 2024.
Data by YCharts.
Over the last 15 years, the S&P 500 has produced a total return of 540% and has only fallen -- at most, by 34.7%. The results were phenomenal if you held an S&P 500 index fund and could cope with that position at one point losing about a third of its value.
All it takes is one glance at the long-term returns of the S&P 500 to see that the best course of action during bear markets is to buy more stocks. An excellent course of action is to simply hold onto the stocks you have. And the worst decision is to sell stocks. However, that doesn't mean you should be complacent or assume your portfolio is invulnerable to long-term issues.
Know what you own and why you own it
Historically, the S&P 500 has eventually recovered from every correction and bear market it experienced, but that doesn't mean that all stocks did.
The past is littered with broken investment theses, failed growth stories, and companies that saw their valuations soar, but then crashed and burned when reality fell short of expectations.
A stock market correction can be an excellent time to review your holdings and ensure that you have a clear reason for owning each stock in your portfolio. Reviewing your index funds and exchange-traded funds (ETFs) is also a good idea.
It's worth remembering, for example, that just because an ETF may have a high number of holdings, that doesn't mean it is well diversified. For example, the Vanguard Growth ETF (NYSEMKT: VUG) -- which, with over $280 billion in net assets, is one of the largest growth ETFs -- has allocated 61% of its assets to just 10 companies.
If you like these 10 companies, you may not find that level of concentration to be a bad thing. But as a general rule of thumb, if you're investing in an ETF, it's prudent to know what its top holdings are, and what stocks account for the majority of its portfolio.
There's no need to get too bogged down in the details of companies that make up less than 1% of a fund. But it is vital to be informed about holdings or sectors that can heavily influence its performance. A whopping 77% of the holdings in the Vanguard Growth ETF are in growth-focused sectors like technology, communications, and consumer discretionary. This means the fund has a low dividend yield and a higher price-to-earnings ratio than the S&P 500.
Getting comfortable with losing money
Peter Lynch, an investment manager known for producing outsize returns for the funds he managed between 1977 and 1990, once gave a speech about stock market corrections and bear markets that has always stuck with me. Here is an excerpt from it:
You need to know that the market's going to go down sometimes. If you're not ready for that, you shouldn't own stocks. And it's good when it happens ... . So you take advantage of the volatility in the market if you understand what you own.
In other words, volatility is simply Wall Street's price of admission. It's an inherent quality of stocks that differs from risk-free assets like certificates of deposit or U.S. Treasury bills.
Lynch makes a good point that you shouldn't own stocks if you're not able to patiently stomach some volatility. But if you can endure the anxiety that you'll feel during market sell-offs, buying and holding stocks for the long term can be a phenomenal way to compound your wealth.
