Falling Markets Reduce Future Risk

Stocks markets are in a correction, loosely defined as a decline of up to 20 percent from recent highs. If stocks fall beyond 20 percent, it is called a bear market. During falling markets most investors just want to know how it might affect them and what they should do about it. I did some personal research and found that since 1928, just before the great depression, there have been about 100 stock market corrections, or roughly one per year. Those corrections have reached bear market status 25 times, or about every four years. That means most investors will experience many of these bear markets over their lifetime. I tell new investors, “If you are not OK with that reality, then don’t get started.”

Though painful, it’s important to know that declining markets are actually a healthy part of the natural cycle. During extended rising markets, investors and the companies they buy, can get lazy and careless. Stressful times force both to reassess priorities, tighten budgets, trim ambitions and re-focus on what is most important. I view it much like pruning a fruit tree where weak and small fruit are removed so that the best fruit can thrive. The temporary reduction in market averages is the result of this economic cleansing or pruning process. Today we are watching the pruning in real-time.

So, what should investors do? First, recognize the stock markets’ amazing track record. Despite 100 corrections and 25 bear markets since 1928, the markets have recovered and grown from every one of them. Legally I am required to remind that past performance is no guarantee of future results, but the markets’ record of recovery over nearly 100 years is a pretty good starting point for making a decision on what to do next. History is no guarantee, but we can learn from it.

During down markets it’s amazing how many people stop me in the store to ask my opinion. In a recent reply I said, “If this store suddenly put everything on sale for 20% off, would your response be – I think I will refuse to shop at this store until they raise prices back to normal?” Yet that is the way many investors approach Wall Street.

This is not to say that every stock will survive. The occasional pruning of Wall Streets’ tree can strengthen markets by cleaning out weak or overpriced companies. The pruning process can be painful. Investors should evaluate their holdings and see if some of them should be replaced. Fortunately, falling markets tend to take even good companies down with them, giving investors a chance to pick up some bargains. It has been said that investors make more money during bear markets, they just don’t know it at the time.

I appreciate the value of market corrections. It’s my personal belief that most declines have followed a period of market excesses that required a pruning. This healthy part of the cycle can actually reduce investor’ risk by making markets more efficient, thus opening the way for the next growth cycle.

Dan Wyson, CFP® is author of “The Gold Egg," and “21 Financial Myths” and owner of Wyson Financial/Wealth Management 375 E. Riverside Dr. St. George, UT 84790 - 435-986-9525 – Securities and Advisory services offered through Commonwealth Financial Network, member FINRA/SIPC, a registered investment advisor