How to Survive a Stock Market Correction

The Dow Jones Industrial Average was less than 500 points away from touching 30,000 before the Coronaviraus arrived and spooked investors. In less than two weeks, the Dow Jones has fallen almost 13%, and it appears the selling will continue until a vaccine arrives, hopefully soon. As the market climbed higher, bears were calling for a correction and they finally got their wish. Stock market corrections are common, and they occur about every three to five years. A bear market lasts approximately 18 months, while a bull market will run for about eight years.[1]

How can you protect yourself against a bear market attack? Here are a few suggestions.

  1. Don’t panic! A market drop is normal, painful, but normal.
  2. Don’t make any changes to your portfolio during the initial phase of a market correction. Let the market find its footing before you make any significant changes to your investments.
  3. Cash is king. If you have a cash cushion, you’re less likely to make rash decisions regarding your stock holdings. How much cash is enough?  My recommendation is for you to hold three to six months of expenses in cash. If your monthly expenses are $10,000, then your cash account should be $30,000 to $60,000.
  4. Invest in U.S. T-Bills if you’re nearing retirement. A suggested amount is three years’ worth of expenses. If your annual expenses are $100,000, invest $300,000. The safety of T-Bills will allow you to survive a typical correction. If you invested in October 2007, you could have lived off your T-Bills for three years while waiting for the Great Recession to end. The Great Recession lasted from 2007 to 2009, where stocks fell 53%, so your bonds allowed your stocks to recover.
  5. Diversify your assets. A balanced portfolio of stocks, bonds, and cash will help cushion the blow from a market drop. During a market drop, your bonds will perform well.  During the 2008 market selloff, long-term U.S. government bonds rose 25.9%.[2]
  6. Rebalance your portfolio. You will sell appreciated investments to buy depressed ones, or buy low and sell high. If you rebalance your portfolio, you can take advantage of lower stock prices. Rebalancing allows you to keep your risk level and asset allocation in check.
  7. Eliminate your margin balance. A sure way to lose more money than you intended is to use leverage.  If you use margin to buy securities, I would encourage you to eliminate it. The best way to make a bad situation worse is to employ excessive margin in a down market.
  8. Stay invested. The two days following the stock market crash of October 19, 1987, the Dow Jones Industrial Average rose 16%. Despite the dramatic drop on Black Monday, the Dow ended 1987 in positive territory, and it has since risen 1,380%, including the recent selloff.[3]
  9. Look for bargains. Is your favorite stock now 25% cheaper? If you’re not sure what to purchase, buy a broad-based index fund.
  10. Think long term. A bear market lasts about 18 months. You may own your investments for years, maybe decades, before you need the money, so think generationally to help you get through the dark days of a market downturn.
  11. Markets recover. The stock market has always recovered! It may take time, but they eventually rebound.
  12. Have fun. The market will go up, down, and sideways long after we’re gone. Instead of worrying about the daily moves in the stock market, get outside, and enjoy your friends, family, and hobbies while you wait for stocks to bounce back.

Stock market corrections come and go. The market is a long-term wealth creation machine occasionally disrupted with short-term pullbacks. If you apply these ideas, you may have an opportunity to benefit from the long-term performance of the stock market.

Even though I walk through the darkest valley, I will fear no evil, for you are with me; your rod and your staff, they comfort me.  ~ Psalm 23:4.

February 27, 2020

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

 

 

[1] https://www.forbes.com/sites/robertlenzner/2015/01/02/bull-markets-last-five-times-longer-than-bear-markets/#12745f772dd5, Robert Lenzer, January 2, 2015, site accessed 3/10/17.

[2] Dimensional Fund Advisors 2016 Matrix Book.

[3] YCharts. DJIA – October 19, 1987 to February 27, 2020.