How to Think About An Inevitable Stock Market Correction

Stock markets go up and they go down — normally.

In fact, in any given calendar year, even in years with positive returns, you will see moments when the overall market is down by 10% or more.

The data prior to 2020 shows drops of 10% or more in 11 of the previous 20 years, averaging 15%. Nevertheless, the long-term average gain over that period was 6% annualized.

Even in the 2020 Covid crash year, when stocks took their quickest decline ever, the S&P 500 still ended the year up by more than 18%!

Now, imagine that I offered you an investment that paid 6% a year like clockwork. You’d take it in an instant. After all, bank interest is virtually nothing and many bond investments pay less than inflation at the moment.

Nobody can offer you that kind of deal, of course. If a return were guaranteed it would either be suspicious or outright fraud. That’s the attraction of Ponzi schemes: It’s a no-lose proposition until it finally collapses and nearly everyone loses their money.

Yet stocks do offer something like that, if you can handle the ups and downs in-between. Over the long run, it’s difficult to find any investment as consistently profitable other than perhaps owning a business, and even then many businesses fail.

The reason stocks are so attractive is the underlying businesses have to make a return or they themselves eventually will go under. If you are an owner of such a business — and owning stock is owning the company — you would expect to share in those gains.

Directly, the profits are paid as dividends. However, in a fast-growing new business you would expect the managers to reinvest the earnings in the pursuit of growth.

That’s why the share price tends to appreciate along with the growth of the business: More investors want in, and there’s not enough shares for everyone to take part in the success.

Too giddy

So why do shares ever go down? Because it’s hard to conceptualize the actual underlying value of millions of shares issued by thousands of companies. Sometimes, investors get a bit too giddy and overpay.

A little bad news comes up and that makes a certain percentage of those buyers turn into sellers, at least in the short run.  Then things seem better and they want back in.

It’s easy to avoid the roulette wheel of buying and selling. All you have to do is own the whole stock market through a low-cost index fund and turn off the news.

The day-to-day and week-to-week gyrations of stocks in the short term are meaningless, if you make it so. A correction will come and go and you might not notice until it’s far too late to take action.

Broadly speaking, that’s a good thing. Taking action while things look gloomy is often a recipe for permanent losses. As the billionaire investor Warren Buffett put it: “The stock market is a device for transferring money from the impatient to the patient.”

Be patient when a correction comes, as it inevitably will, and you will not regret it once the market shakes off the gloom and recovers.

MarketRiders, Inc. is a registered investment adviser.  Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies.  Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.