Stocks have taken a beating in January. The S&P 500 index, a widely cited barometer of U.S. equities, touched into “correction” territory for the first time since the pandemic-fueled market turmoil in March 2020.
Just what does that mean and what should investors know?
A “correction” applies when stocks fall 10% or more from a recent high.
In a wild day of trading on Monday, the S&P 500 stock index — a basket of the country’s largest publicly traded companies — sustained heavy losses. At one point it was down more than 10% from its high mark on Jan. 3.
The index eked out a slight gain after a late-day rally, but was again teetering on a correction as of early afternoon New York time on Tuesday.
But investors shouldn’t panic — the ups and downs are a regular feature of stocks, according to financial experts. Investors who sell as a gut reaction to the carnage often do themselves financial harm in the long run.
“It’s not very rare to see them,” Stephanie Roth, senior markets economist at J.P. Morgan Private Bank, said of corrections. “But of course every time you’re in one, it doesn’t feel good.”
The S&P 500 has experienced a correction in 21 of the last 41 years, according to J.P. Morgan Private Bank.
However, U.S. stocks delivered a positive annual return in two of every three years in which a correction occurred. That suggests staying invested over the long run pays off — though data suggests investors often sell during dips and miss those recoveries, according to J.P. Morgan.
Volatility is a key feature of stocks — a risk that generally rewards long-term investors.
“It’s ‘stay the course’ – the market goes up and down,” Dan Herron, a certified financial planner and founder of Elemental Wealth Advisors in San Luis Obispo, California, said of his typical advice to clients during stock gyrations.
In fact, it may be a good opportunity to buy more stocks, for investors who have the means, since stocks are selling at a discount from recent high prices, Herron said. The dynamic of falling stocks may also mean investors’ portfolios are automatically rebalancing themselves to their target weighting of stocks to bonds, following a year of lofty stock returns in 2021.
Missing big positive swings in stocks, which often occur within days of the initial plunge, can have a significant impact on one’s returns.
For example, a $10,000 investment in the S&P 500 would have yielded a roughly 9.2% average annual return from December 2001 to December 2021, according to J.P. Morgan Asset Management.
But that return fell by almost half (to about 5%) for investors who sold and missed the 10 best days over that period; it was almost 0% for those who missed the 30 best days.
Since 1945, investors have taken four months, on average, to recover from a pullback of 10% to 20% in the S&P 500, according to Guggenheim Investments.
Recovery from a plunge of 20% to 40%, a much rarer occurrence, took 14 months. Drops of 40% or more, which have happened just three times, have taken 58 months, according to Guggenheim.
Problem is, it’s impossible to know how long the pain will last and how deep it will be when investors are in its throes.
Time horizon and the reason for invested funds are key considerations for investors gauging what to do, according to CFP Ted Jenkin, the CEO and co-founder of oXYGen Financial.
“The most important single thing [in this situation] is knowing what your financial plan is telling you what to do,” Jenkin said. “If you have five or more years, you can be in the stock market, you don’t really have an issue what happens day to day or week to week.”
However, some investors may be invested in stocks for more immediate needs, like funding a kid’s college education or buying a house within a few months, Jenkin said.
Stocks are generally not the ideal place for such short-term funds given their risk. Such investors may have to make a tough decision: keep those funds in the market if the market recovers, or risk incurring more losses in the short term, he said.
“This is the gamble: Do you bet on red or black?” Jenkin said.