MENU

Why You Need Not Fear Stock Market Corrections

Following what seemed like one of the least volatile years in recent history, the stock market has been anything but calm in 2018.

Beginning in late January, it took just 13 calendar days for the nearly 122-year-old Dow Jones Industrial Average and S&P 500 to tumble more than 10% from their January 26 2018 record-closing highs. After more than two years, investors were looking at a genuine stock market correction.

Stock market corrections, though common, are a source of fear

Of course, corrections themselves aren’t uncommon.

Market analytics firm, Yardeni Research, offers detailed analyses of corrections and bear markets (drops of 20% or more from a recent high) dating all the way back to 1929.

Since 1950, there have been 36 separate instances where the broad-based S&P 500 has tumbled by a minimum of 10% — i.e., official correction territory — suggesting that, on average, a correction occurs about once every two years. Nevertheless, a regular dose of corrections hasn’t seemed to lessen the panic that hits retail investors when they strike.

Earlier this year, we’ve witnessed veritable doomsday headlines from various news outlets every time the iconic Dow seemingly drops more than a few hundred points.

  • Dow plunges 724 points as trade war fears rock Wall Street” — CNN Money, March 22 2018
  • The Stock Market Is Crashing. Here’s What You Should Do” — Time, February 5 2018
  • Stocks Collapse: Dow Suffers Worst One-Day Point Drop Ever” — RTT News, February 5 2018
  • Carl Icahn Warns Volatile Stock Market Will ‘Implode’ One Day” — Fortune, February 6 2018

If I read these headlines, I wouldn’t want to get out of bed or invest in the stock market, either. And that’s a growing concern.

The diagram below shows the maximum decline from peak-to-trough for the Singapore stock market benchmark, the Straits Times Index (SGX: ^STI), for each year from 1993 to 2016, a period of 24 years:

Source: S&P Global Market Intelligence

Of the 24-year period above, all but three years saw a 10% decline or more. To simplify, nine out of every 10 years saw a more than 10% fall from peak-to-trough. That’s a high probability.

Behold the power of long-term investing

Yet, we know from historical data that the stock market offers the best chance of wealth creation over the long run. That wealth creation will, however, come with some bumps in the road. If you’re still skeptical about the power of long-term investing, here’s some data that just might change your mind.

Source: Fool.com article (Total annual return includes dividends. Colour coding in annualised return column denotes strength of five-year returns.)

Above is a table outlining the annual returns in the S&P 500, inclusive of dividends, since 1970. Also listed is the trailing-five-year annualised return rate for each year, beginning in 1974.

What stands out? How about the fact that out of 44 years of five-year annualised returns, just seven of those years had a negative trailing average. Further, of those seven years, the annualised negative return ranged between just minus 0.21% and minus 2.35%. Even though investors lost money over these five-year stretches, the annualised loss rate was truly minimal.

Now compare that to the 37 years where the annualised five-year return was positive. In 27 of 37 years, the five-year annualised return rate was more than 10.7%. In fact, the median annualised five-year return rate over this 44-year-period is a mind-blowing 14%, inclusive of dividends. That’d lead to an average doubling of your money in less than six years, assuming the averages held up.

What do all these mean?

Now that you’ve been bombarded with data, you’re probably wondering what the main takeaway is. Put simply, if you buy high-quality stocks in regular intervals (once a week, month, or quarter, for example), history shows you should come out ahead over the long run.

Look, there’s no way to know in advance when a correction or bear market is going to strike, how much the indexes will drop, or how long a correction or bear market will take to resolve. But what we do know is that every single correction in history, save for our current correction, has been eventually erased by a bull market rally, often within a matter of weeks or months. Though nothing is a given when it comes to investing, we’re talking about an event — erasing corrections with a bull market rally — that has had a 100% historic success rate. That’s as close to a guarantee as you’re going to get in the stock market, but it only works if you commit to your holdings for the long term.

In other words, aim for the horizon and stop sweating what happens until you get there.

Still worried about the overall state of the market? Do you know the 1 thing you should never do in the stock market? The Motley Fool Singapore’s new e-book lays out a plan to handle market crashes, details the greatest advantage you have as an investor, and looks at decades worth of market data to bring you the smartest insights on investing. You can download the full e-book FREE of charge—Simply click here now to claim your copy

This article was written by Sean Williams, and first published on Fool.com. It has been edited for Fool.sg. The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.