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 it 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 2 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 (2 to 5 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 401k 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 you 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 lately?
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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.
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.
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