FINANCIAL SAVVY: Managing equity market downturns

What is an investor to do when a market correction occurs?

Five years into North American and world-wide Bull markets, Canada’s TSX is approaching new all-time highs. U.S. markets passed their pre-2008 highs some months ago. So what is an investor to do when a market correction occurs?

After a lengthy bullish run, stock markets always correct. No one can predict the timing of a correction — though many investors try to do so. What we do know, is that in the past sixty years North American markets have experienced 12 Bull markets and 12 Bear markets. These terms are generally applied to market changes exceeding 15 per cent, and lasting at least six months.

Canada’s Bull markets over the past sixty years have had an average duration of 44 months, while delivering an average 120 per cent total gain in the TSX Index. The Bear markets on the other hand, have averaged only nine months’ duration, with an average  value reduction of 26 per cent.

Clearly, the Canadian investor should take note of these instructive facts about how markets perform and periodically adjust. It has been demonstrated investors who are well-invested and remain so during market downturns, dramatically outperform those who panic and sell holdings when markets fall.

Those investors who sell in declining markets are rarely successful in buying back near the market bottom when the inevitable market recovery occurs. Usually, they lose out compared to the stay-put investor who continues to collect regular dividends throughout the adjustment period.

The winning strategy of staying invested is particularly effective for those investors who are mainly in low-cost, highly-diversified, dividend-paying securities and with an appropriate Fixed Income component in their portfolios. During a downturn, such portfolios should in fact decline less than the general market. During upswings, these portfolios should outperform the broader market.

A key point for investors to remember: A loss is not incurred during a market correction, unless investments are actually sold. Although market values will certainly show a reduction on paper, such reductions, as history has repeatedly proven, are much briefer and less severe than the increases resulting from the also inevitable market upturns.

As some pundits believe, North American markets may well continue to climb for some time. They cite low interest rates, solid corporate balance sheets and earnings, declining unemployment, and a growing gross domestic product. Others argue that with record high markets and their extended Bull run, we are overdue for a correction.

As a Harvard Business School professor recently concluded after studying a 10-year period of predictions of 100 such prognosticators, the accuracy of their predictions was about as reliable as that of a monkey throwing a dart at a predictive dartboard. If the “experts” cannot predict market moves, it’s even less likely that the average investor can do so.

A market correction, when it occurs, is a normal cyclical phenomenon, the timing of which is totally unpredictable. The best course of action, usually, is to take no action at all.

 

A retired corporate executive, enjoying post-retirement as an independent Financial Consultant (www.dolezalconsultants.ca), Peter Dolezal is the author of three books, including his most recent, The SMART CANADIAN WEALTH-BUILDER.

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