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Why you should never fear a market correction

Given recent events, I wouldn’t blame anyone for feeling considerably less comfortable about their investments this week compared to last. Thanks to 24/7 news coverage and our all-too-human tendency to follow the herd, it’s not easy holding your nerve when everyone else in the markets appears to be reaching for the sell button.

That said, a brief reminder of financial history should encourage all long-term investors to learn to treasure — yes, treasure — market corrections when they happen. Let me explain.

Inevitable and normal

The fact is, corrections (defined as a fall of 10% or more in the value of an index) are completely normal. As the psychologist and behavioural finance expert Daniel Crosby noted in ‘The Laws of Wealth’, the US stock market experienced 123 such events between 1900 and 2013 — an average of more than once a year. 

What’s more, corrections are quickly forgotten. Think back to the EU referendum vote in 2016. On the day the result was announced, the FTSE 100 and FTSE 250 plummeted as investors were shaken by the uncertainty of what Brexit would actually look like. Anyone deciding to leave the market at that point would have missed the huge rally that occurred over the following 18 months.

To be clear, we shouldn’t fear corrections, particularly this one. In addition to allowing an overheating market to cool, it’s also provided investors with the chance to reassess their expectations, check their asset allocation and remember what they can and can’t control.

Even a more extreme fall or bear market is fairly common — happening roughly every 3.5 years in the US, according to Crosby. As a result, your average long-term investor can expect to experience 10 to 12 of these in their lifetime. Call up a chart of the FTSE 100 since its inception in 1984 and you’ll see much the same trend — an upward curve from left to right punctuated with problematic periods, most recently 2000-2003 and 2007-2009.

Be prepared

Having recognised that corrections happen fairly regularly, we then need to think about how we might prepare ourselves if markets continue to wobble next week, next month or over the rest of 2018.

Any plan of action will naturally depend on your investing horizon. If you intend to remain in the stock market for the next few decades rather than the next few years, you can safely do nothing.

If this sounds too difficult, consider taking a correction as an opportunity to re-evaluate your portfolio and check it’s appropriately diversified. If the investment case for every single one of your stocks still holds, you may wish to take advantage of a fall in prices and add to your positions. Alternatively, you may consider buying shares in quality companies that have hitherto been prohibitively expensive. This is why, as an investor, it’s always worth keeping some cash in reserve. The only thing to worry about when it comes to corrections is not being able to go on a shopping spree when they occur.  

In contrast, those nearing retirement or wishing to access their capital in the near future may want to reduce their risk somewhat, particularly if the last few days have been more than just a little difficult. Since being kept awake at night by your investments should never be part of the plan, it might be prudent to trim positions in some of your more speculative holdings.

Your investing edge

Being able to sit still while others are panicking, safe in the knowledge that equity markets regularly correct, occasionally crash and eventually recover is essential if you're to become a successful investor

For more suggestions on how you can improve your chances of walking away from the market substantially more wealthy than when you entered, just download a special report from the Fool's analysts. It's completely FREE to read and comes with absolutely no obligation.

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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.