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Finance / Money / Personal Finance

The right decision for investors to take when a market correction is due

The right decision for investors to take when a market correction is due

It’s a question being discussed in the financial media quite a bit lately. With markets hitting record high after record high, when is the other shoe going to drop? Aren’t we due for a correction in the market? If so, is it time to get out?

Yes, the market is due for a correction. That doesn’t necessarily mean a return to the crisis of 2008 and 2009. A correction is a negative reverse movement of an index of at least 10 percent. While sometimes used interchangeably, this technically differs from a bear market, which is a downturn of 20 percent or more over a two-month period or more.

These events don’t always take place across asset classes at the same time. Sometimes, certain countries or parts of the world experience these events independently. Sometimes certain sectors or industries (think big retailers of late) do the same. Every once in a great while, the broader market as a whole is impacted, sometimes in historic proportions, as we saw near the end of the last decade.

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The technical date of “the bottom” of that 2008-2009 financial crisis was March 9, 2009. There were many stories out there about investors selling out of stocks, many at or near the bottom, out of fear. This is understandable. Fear is a powerful force and, at the time, we were dealing with one of the worst markets on record. But was it the optimal choice?

Let’s say, for sake of argument, someone could pull out of the market earlier than most. That their stock portfolio only dropped by 20 percent before deciding to realize all those losses by selling. That may have felt like good timing or the right idea to some in the moment. Given what we know now, and what we’ve always known about markets, the tougher question came after the selling.

On a ride from Dow 6,500 to Dow 23,000, with much of the world market following suit, when, if ever, did most of those investors get back in?

I was looking at the performance of the broader equity asset classes we use to build portfolios at my firm, The Asset Advisory Group. To keep it simple, I’ll break the market down into U.S. stocks, international developed stocks, emerging markets and global real estate. These markets were all punished severely over that 2008 to early 2009 historic bear market.

When did the greatest portion of the rebound occur? With all the positive moves in the market over the last few years, which quarter over that period produced the best performance for these various asset classes? In fact, you can go all the way back to 2001 and still get the same answer. Since January 2001, the best-performing quarter for each area of the market follows:

If we are to invest in the stock market, we must recognize that determining how much we allocate towards stocks, bonds and other areas of the market is a — if not the — crucial decision. This decision should be based on more than just what we expect our long-term return will be. More important is knowing that the allocation we select is well aligned with our tolerance for risk.

We know with certainty that markets will go up and down in the short and intermediate term. We also know that, in the long run, markets will provide a reasonable return for the risk taken. To earn that return, which few investors truly optimize, we must be disciplined both in our approach to rebalancing portfolios and in our willingness to stay invested.

Missing out on the best few days in decades of investing can have a tremendous impact. Earning those “best quarter” returns above is an important step in ensuring a portfolio is resilient enough to weather the losses we know will come from time to time. Maintaining a strict rebalancing discipline means buying into stocks when they’re heading south, which allows investors to earn that much more when a period like the second and third quarters of 2009 comes around.

I don’t suspect another 2008/2009 financial crisis on the horizon. Historically, we should not see anything like that again for quite some time. We will see bear markets and bull markets, market corrections up and market corrections down. We monitor portfolios here at TAAG vigilantly to ensure we’re taking advantage of opportunities to sell high and buy low regardless of the current environment. This discipline has proved successful for nearly 30 years. We suspect it will continue for at least that many more.

(Editor’s Note: This column originally appeared at Investopedia.com.)

— By Chip Workman, president of The Asset Advisory Group

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