Last week the stock market sold off almost 2% and signaled that it could be the start of a correction. We’ve been here before though (in January), and the stock market just rebounded to all-time highs.
However, in any good long-term bull market, there are corrections, where the stock market drops by 10%. It’s good for the market to pull back a bit and allow investors to “feel” like they are getting some value for their money.
If you’re a long-term investor, a correction should make too much of an impact on your portfolio. However, there are some simple steps that you can take today to prepare — and they will help you whether the stock market goes up or down!
Understand Your Investment Strategy
The first thing you need to do is think about and understand what your investment strategy is for. Are you investing for retirement? Are you saving for your first house? Are you investing for your kid’s college?
When thinking about your strategy, you really need to think about two factors:
- Time horizon — how long the money will be invested.
- Risk tolerance — how comfortable you are with losing money.
If you have a short time horizon (less than two years), you should take the money you need out of the stock market. This applies to waiting on a correction, but it also applies to general investing strategies. If there is a drop in the stock market, it can take years to recover, and if you need that money, it shouldn’t be invested.
If you have a medium time horizon (two to five years), you should take a less risky approach to your money, investing in a diversified bond portfolio or other investment that will hold value.
Finally, if you have a long time horizon, don’t change your strategy and stay invested in the stock market.
Look at Your Asset Allocation
Next, once you decide your investment strategy, you should look at how your asset allocation plays to that. In our Investing 101 course, we go over model asset allocations for each type of strategy, but depending on your time horizon, you may want to be more conservative with your investments.
It’s also important to remember to plan your asset allocation across multiple investment accounts. If you have a Roth IRA and a 401(k) at work, you need to plan out everything holistically. Just because you have one account in the right balance to meet your investment strategies, it can be hard to get your entire portfolio in-line unless you follow those strategies.
And remember, just because you did it last year doesn’t mean you get to skip it this year. After a bull market like the one we’ve had, you need to reassess where your asset allocation is.
Relax
Finally, you need to relax. If you’re a long-term investor, don’t sweat a small market correction, or even a full sell-off. Just make sure that you have a properly-allocated portfolio, and use corrections and sell-offs as potential buying opportunities. They aren’t something to be fearful of.
If you’ve lost money investing because of the sell-off, realize that it will come back even stronger than before.
Have you done anything to prepare for a potential stock market correction? Have you checked your asset allocation recently?
Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him here.
He regularly writes about investing, student loan debt, and general personal finance topics geared towards anyone wanting to earn more, get out of debt, and start building wealth for the future.
He has been quoted in major publications including the New York Times, Washington Post, Fox, ABC, NBC, and more. He is also a regular contributor to Forbes.
MoneySmartGuides says
Nice post. The market is going to pull back at some point – it always does and always will. The key for long-term investors is to remember why they are investing in the first place and to make sure they have their asset allocation correct. Making sure you have that down will take a good bit of the fear away when the market drops.
Money Beagle says
Good stuff. I think that having a strategy and sticking to it is key. So often we get content and we forget to plan, or we plan but then we panic and don’t execute the plan, and no matter how it works out, we end up taking money away from ourselves.
Roadmap2Retire says
Good post, Robert. A timely reminder as we are at all-time highs. Asset allocations are key to protect yourself from major losses. The risk decreases significantly when your assets are invested in a handful of good companies. It is also important to not just focus on sector allocation, but also the asset classes.
Best