Stop Doing # 6: Stop Trying to Correct for Market Corrections

By Steve Lowrie, Lowrie Financial

Special to the Financial Independence Hub

Recently, the market has been playing right into an important addition to our financial “STOP Doing” list: Stop trying to correct for market corrections.

The subject is not a new one to us. In August 2014, we posted this Q&A: “Is there going to be a market correction (and, if yes, then what)? In light of current events, we’ve now updated that post with 2014 year-end information.

Just as it takes no special skill to predict some days of sub-zero temperatures this winter, we were not being prescient a year ago, when we said that we would probably experience a correction sooner or later. One need only consider abundantly available evidence to recognize that, viewed seasonally, the market frequently “corrects” itself, sometimes dramatically. It’s only when we take the long view that we can see the market’s overall upward movement through the years.

For example, consider the Dimensional Fund Advisors slide shown below, which depicts the U.S. stock market’s gains and losses over the past 35 years. The narrow lines illustrate wide swings of maximum gains and losses in any given year. The blue bars show the year-end gains and losses after the dust has settled. Clearly, far more years ended up than down, for overall abundant growth.

This illustration is substantiated by similar findings from JP Morgan, which we shared in our Q&A. According to their data, covering 1980–2014, the average intra-year decline of US stocks (measured by the S&P 500) was 14.2% per year, but the annual returns were positive more than 77 percent of the time, in 27 out of those 35 years.

“Correction” is not a useful term

But we’d like to challenge the word “correction” to begin with. We prefer to think of price volatility as simply part of doing business in the market to begin with. Ever the individual to tell it like it is, Dimensional Fund Advisor’s retired executive Dan Wheeler had this to say in one of his recent blog posts, “The Spinning ‘Talking Heads’”:

I never have liked the term “correction” to explain a move in the market indices. By definition it implies that the market “got it wrong,” being under or over valued. So looking at the market as I write this, I guess the past few days the market “over corrected” and has now “corrected” the “correction.” You can see how this starts to become a bit silly, but it also shows how little credibility should be given to the “talking heads” and journalists posing as “experts.”

From this perspective, investors are best advised to stop seeking to correct their own investments in the face of market corrections … if that’s what you want to call them. Here are a half-dozen additional insights to be gained from the recent losses:

• Corrections happen. But like this winter’s weather, we cannot foretell precisely when they’ll occur, how severe they will be or how long they might last.
• If there is any real surprise to the most recent correction, it’s that it didn’t happen sooner. We had gone almost three years without any meaningful pullback, which happens to be one of the longest relatively smooth runs we’ve experienced for a long time.
• When the markets do recover, they tend to do so suddenly, dramatically and without warning. If you try to dodge the downturns, odds are that you’ll miss some of the best upturns that often follow on their heels.
• If we haven’t already made this abundantly clear, we believe the best course of action is to be guided by your personal financial goals rather than near-term market volatility; this almost always means staying the course during the downturns.
• To help stay the course, it’s vital to have enough liquidity for your purposes, so you can continue to comfortably meet any cash-withdrawal and short-term financial needs.
• Whether it’s ensuring sufficient liquidity or managing the degree of risk you’re willing to take in your investing, prepare for downturns routinely and in advance, so you won’t need to panic-sell when prices are low. As Behavior Gap author Carl Richards has observed, “It’s not a good idea to figure out how a parachute works after you jump out of the plane.”

Steve Lowrie holds the CFA designation and has over 20 years of experience dealing with individual investors. Before creating Lowrie Financial in 2009, he worked at various Bay Street brokerage firms both as an advisor and in management. “I help investors ignore the Wall and Bay Street hype and hysteria, and focus on what’s best for themselves.”