By Mike Gertsema, Senior Wealth Advisor
Market corrections or drops can cause a lot of stress and concern for some investors. A market correction is when the market drops 10% or more. It’s called a market correction because, historically, the drop often “corrects” and returns prices to their longer-term trend.
When we meet with our financial planning clients, we like to discuss historical information to illustrate how market corrections are a normal part of investing and something we plan for when constructing a portfolio.
Historical Stock Market Corrections
According to the RIMES data company, the Standard & Poor’s 500 Composite Index (S&P 500) from 1948-2017 has experienced many corrections due to different events. Their data indicates that we generally see:
- A 5% or more drop, and it happens about three times per year; on average, it takes 46 days to recover from the drop.
- A 10% or more correction about once per year; on average, it takes 117 days to recover from the drop.
- A 15% or more correction about once every 3.5 years, on average, it takes 275 days to recover from the drop.
- A 20% or more correction about once every 6.3 years; on average, it takes 425 days to recover from the drop.
According to a CNBC headline on February 22, 2022, the S&P 500 closed at 4,225.50, which is a nearly 12% drop from its record-high close on January 3, 2022.
While we can’t predict the markets and when a correction will occur, we can be cognitive of market corrections and ways to insulate our clients from the potential stress and anxiety associated with them.
Portfolio Stress Tests
We have the technology, tools and educational resources to run stress test scenarios on our client’s current portfolio or proposed portfolio. The stress test gives us the following:
- A percentage breakdown of equity and bonds in the portfolio.
- The risk in the portfolio with scenarios in the next three months of a 20% drop, a 10% drop, Treasury Rates increases and market increases of 10% or 20%.
- The historical average rate of return of the portfolio and the maximum drawdown on a market correction over a set time period.
- It also breaks down the internal fees paid within the portfolio and different metrics of risk and returns – for example the Total Return, Maximum Drawdown and Volatility.
The goal of the stress test is to measure risk and manage expectations for our clients. Making the best rate of return is important, but managing risk is sometimes more important with retired clients.
Market Correction Opportunities
When you are making contributions to retirement accounts, a correction can create a possible buying opportunity. When you are relying on your portfolio for income, having to sell investments when the market is down can have a negative effect on your long-term plan. If we manage the downside risk, the upside should take care of itself. Give Your Portfolio a Check Up
Bucket Investing Strategies
We also use a strategy called bucketing with your investments based on the overall income need, when the income is needed and the client’s risk tolerance. The information is helpful and has an impact on the overall financial plan, income tax plan and estate plan.
An example of bucketing looks like this:
This is not a set-it-and-forget-it-type strategy. The investments in each bucket will change over time based on market conditions and changes in the financial plan, which is updated at least annually.
We also try to keep Bucket #1 and Bucket #2 full when we see market rallies. So, for example, when the S&P 500 is reaching new highs, it’s an excellent time to rebalance, taking profits from Bucket #3 and refilling Bucket #1 and Bucket #2. If possible, we prefer to stay five years in front of our clients’ cashflow needs. Given the information on market corrections and the time it takes for the market to recover from corrections, this makes it very helpful to manage the client’s cashflow and maximize investment returns.
At Gertsema Wealth Advisors, we take a team approach with our clients and our financial planning process. Investments, managing risk, managing client’s monthly income needs, explaining market corrections, portfolio stress tests and bucketing are only part of the value we provide to our clients daily. If you’d like to learn more, or you’re interested in a complimentary consultation, please call or text 816-259-5060 or contact us online.
S&P 500 – A capitalization-weighed index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.