No one likes when the stock market goes down! Also known as a correction, this is generally defined as a decline of 10 percent or greater in the price of a security from its most recent peak. According to Investopedia, corrections can occur in individual stocks, indexes, commodities, currencies, or any asset that is traded on an exchange. In fact, stock market corrections are a normal part of investing and can be a great time for investors to buy quality stocks at discounted prices.
To prepare for the inevitable market correction, it’s important to know your investing comfort zone and lay the groundwork ahead of time to avoid being caught off-guard. There are a few things you can do that will help you build a foundation for investing properly. The first step is understanding your risk tolerance, which is your willingness to withstand large swings in the value of your investments. The more risk you’re willing to take, the greater the potential reward. There are questionnaires and surveys that can be used as a tool to help measure your risk tolerance. It can also be helpful to work with a financial planner, who can guide you in the right direction.
The next step is making sure that your investment strategy is tied to your financial goals. For pre-retirees and retirees with a shorter time horizon, this may mean designing a portfolio of income-producing investments such as bonds and dividend-paying stocks.
The next step—and perhaps most important—is to stay calm during any market correction to avoid panic selling, as things tend to even themselves out over time.
Although they can be difficult to stomach, market corrections occur once per year on average. Understanding your risk tolerance and matching the investment strategy to your financial plan will help you make better financial decisions and feel more comfortable with investing.
- Complete a risk tolerance questionnaire or survey. To help understand your tolerance for market corrections, it’s important to know your risk tolerance. Find a FREE survey or questionnaire online; most financial institutions such as Vanguard and Schwab offer a questionnaire on their websites. If you work with a financial planner, they should be able to provide one to you, as well.
- Review your investment strategy. Make sure it aligns with your financial goals. Depending on your age, time horizon, and retirement goals, your investment strategy should be allocated accordingly. For example, someone with 20-plus years until retirement will generally want a higher allocation to stocks than bonds.
- Don’t panic. When the market is going through a correction, stay calm and focus on your long-term financial goals. Generally, corrections are short-lived, and selling while your investments are down is almost never the right decision.
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