As markets seesaw, thinking calmly is important to my long-term returns as an investor. Here are three ways I could handle a market correction. I like two of them and will avoid one. Let me explain why.
Do nothing
One way of handling a market correction is simply to sit back and do nothing, for months or even years in some cases.
That may seem at odds with the always-on culture and need for constant action that have become more common in the digital age. But some leading investors reckon that the key to long-term success is not frequent activity, but making a small number of high-quality investments. Let’s say I own Unilever or Tesco, for example. Their share prices could well fall along with other shares in a market correction.
But if the underlying investment case that attracted me to the shares before a market correction has not changed, then my valuation of the businesses will probably not have changed much either. Falling share prices may shake my confidence in the shares, but if I felt the investment case was solid when I bought the shares and the facts have not changed much, as a long-term investor I could do nothing and wait in the hope that the share price will recover in future.
Use a market correction as a buying opportunity
In fact, if a share I own has crashed in price, it could be a buying opportunity for my portfolio. Basically I can buy what I bought before, on sale. Sometimes that can be hard psychologically, as it could make me feel I overpaid before. But if I am confident in the investment case and the price has fallen, logically I think it makes sense to consider buying more of the shares for my portfolio. One thing to watch out for with this approach, however, is the importance of maintaining a diversified portfolio as a way of reducing risk. Buying more shares in companies I already own could make my portfolio less diversified.
I would also apply this approach to companies I like but have seen as overvalued. For example, stocks like Howden Joinery, Victrex and Judges Scientific have all caught my eye. But I have seen their share prices as too high to add them to my portfolio. If a market correction leads to their prices tumbling, that could present me with a buying opportunity.
Jump in and out
A lot of people see a market correction as a chance to jump in and out of shares, hoping to make fat profits from wild price swings in a short period of time.
The downside I see to that approach is that it is not investing, but simply speculating. Instead of buying shares in companies based on the attractiveness of their long-term business prospects, it involves making choices based on price. In a market correction, there can be far more volatility then normal on stock markets.
As an investor with a long-term horizon, I do not adopt this approach in a market correction. Instead, I focus on the same investment style I use when markets are calm: identifying great businesses at an attractive price I can hold in my portfolio for the long term.
