3 Ways to Protect Yourself in a Stock Market Correction

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Well, nothing lasts forever right? The Dow Jones industrial average is down about 1,200 points, or 4.6 percent, since just last week. With major indices down nearly 5 percent from their highs, this pullback could worsen. What should investors do if they find themselves in a stock market correction?

In a normal market, it’s not unusual to experience at least one correction (defined as a decline of 10 percent or more) a year. But the market hasn’t been very normal recently.

There hasn’t been a correction in the Standard & Poor’s 500 index since early 2016. Prior to that, however, there were nine market corrections between 2010 and 2015.

Point being: After an abnormally long period of rising stocks and no meaningful pullbacks, it pays to put things in perspective. Corrections are unavoidable and to be expected.

Still, sell-offs are still disquieting for most investors. Here are three tips for how to deal with a stock market correction. All of them will make you a better investor.

Consider it a chance to review the quality of your investments. “Why did I hold this stock? What about this fund – what did I see in that in the first place? Maybe I don’t really know as much as I should about this security. Maybe I’m flying by the seat of my pants.”

If you find yourself thinking like this, it could be a warning sign to heed. Think back to your rationale for buying the stock or fund in the first place: Did you buy it simply because it was hyped and going higher, or for some deeper reason? How confident are you in its strategy and positioning? Do you know enough about it to say?

If you don’t know enough about a holding to express confidence in its strategy, you shouldn’t own it in the first place: Sell immediately. If you do know enough about it and aren’t confident in its strategy, why are you holding in the first place? Sell it, now. And if you’re both knowledgeable and confident, what are you sweating? You might even consider buying more.

A stock market correction can also serve as a great motivator to start developing certain exceptional habits. One simple practice that everyone can (and should) do: Develop the habit of writing down, the day you buy or sell a security, why you made that decision. Over time, you may start noticing common mistakes you’ve made and avoid them in the future.

Take a market correction as an opportunity to review your strategy. Are you OK losing 20 to 30 percent on paper in any given year? No? Get out of the market. Would you sell at the bottom if another crisis like 2008-2009 popped up again? Yes? Congratulations, your honesty may save you a small fortune. Don’t keep your money in stocks.

If you accept the fact that short-term gyrations will cause big paper losses in any given year, but that patience is rewarded in the long term, then a mere stock market correction of 10 percent is nothing to fret about.

Again, it may even be the time to buy more – especially if you know enough about the strength of the underlying economy or the fundamentals of a particular business and remain optimistic.

The cardinal rule: Do nothing. Lastly, a great rule of thumb: In investing, sins of commission far outweigh sins of omission. Investors trade too much, and the more one trades, the poorer they seem to do. Active mutual fund managers routinely fail to beat passive mutual fund managers; over 82 percent of large-cap funds failed to beat the humble S&P 500 index over the last five years.

Think of it this way: You can beat 82 percent of professional fund managers by just buying a low-cost index fund.

Of course, that’s easy to do in theory. Practice has a habit of being a little tougher.

Over the last 20 years, the S&P 500 rose by an annualized 7.7 percent. This is a fabulous return compared to almost any other asset class: A $100,000 investment in the S&P 20 years ago would have compounded into $440,873.57 today (before fees), if all you did was buy and hold. If all you did was nothing.

Instead, the average investor has earned – brace yourself – a meager 2.3 percent annually over the last 20 years. Today, that $100,000 nest egg is worth $157,584.20. When you factor in inflation, which was 2.1 percent a year, most investors barely managed to break even.

That’s a truly heartbreaking statistic. With so many baby boomers entering retirement, the costs of health care and education rising faster than inflation, and many millennials unable to afford a home, one of the best avenues for building wealth has failed the average American.

That’s the bad news.

Here’s the good news: That underperformance is largely due to the investor’s biggest enemy: himself. The urge to buy when prices are rising and sell when they’re falling. If you can condition yourself to do the opposite, that’s great. But even if you can train yourself to do nothing, you’ll be way ahead of the pack.

Top Blue-Chip Stocks to Buy

Stock Name 1 Year Return
Apple Inc AAPL 26.25%
3M Co MMM 42.75%
Cisco Systems Inc CSCO 34.39%
Exxon Mobil Corp XOM 4.85%
General Electric Co GE 44.51%
The Home Depot Inc HD 43.16%
Intel Corp INTC 28.61%
Johnson & Johnson JNJ 24.08%
Microsoft Corp MSFT 46.62%
Amazon.com Inc AMZN 76.49%

Stock information as of February 5th, 2018

John Divine is an investing reporter for U.S. News & World Report, where he covers financial markets and the economy, with a focus on individual stock analys… full bio »