How to Take Advantage of a Market Correction

The picture above is a wordle we created by taking words from this week’s market headlines. Not familiar with the term wordle? We’ve got you covered. It’s an applet by which word clouds can be created on a computer.

Markets have been extremely volatile. From August 18th to the 25th (only 6 trading days), the Dow Jones Industrial Average dropped 10.6%. Because the drop was greater than 10%, we technically just had a correction. The question on everyone’s mind is what should I do. Should I sell, buy, or sit on my hands? And the answer is…all of the above. Here are five things you can do to take advantage of a correction:

Keep your emotions in check

Take a breath, understand your first thought is driven by emotion. Behavioral finance studies prove we strongly prefer avoiding losses than acquiring gains. In fact, losses are as much as twice as psychologically powerful as gains. Successful investing is not easy, it takes discipline in stomaching rough patches to achieve positive long-term results.

Ignore the people that say this time is different

If we had a nickel for every time we heard that phrase we’d be on an island managing our own money! Corrections are very normal. Over the last 35 years the annual, intra-year drop has averaged -14.2%. A more interesting fact is markets have finished positive in 27 of those 35 years.

Focus on saving and invest

Push yourself to save more and invest when a correction happens. If you have “non-emergency bucket” money, put it to work. Investing at different times reduces your risk and improves your long-term success.

Rebalance your accounts

Conduct a review of your asset allocation and confirm you are in line with your plan. If you are supposed to have 60% in stocks and now find you have 55%, sell bonds and buy stock to get back to your asset allocation.

Proactively manage taxes in your accounts

Look at your accounts and sell positions with an unrealized loss and immediately buy another investment in the same asset class. This way you stay invested and get to use those now realized losses to offset future gains or ordinary income on your next tax return.

Market corrections can lead to tremendous opportunity. Go ahead sell, buy, sit on your hands and take advantage of this recent drop in stock prices.

Sources:
http://loss-aversion.behaviouralfinance.net/
www.morningstar.com
www.realclearmarkets.com