A stock market correction is an inevitability. In recent history, we saw two 10% corrections in 2018, a 13% correction in 2016, a 12.4% correction in 2015, a 20% correction in 2011, a 16% correction in 2010, and a -57% correction in 2009.
Then of course, we saw the fastest correction in history, a 32% correction in just one month in March 2020. At least I wrote about investing in the bottom then.
Whenever there is a stock market correction after long periods of stable growth, it always feels bad. Although it’s never fun to lose money, it’s good to face the situation head on and focus on the positives and what we can learn.
With valuations so high in the S&P 500 today, expect another stock market correction in the near future. Margin debt is way up, which makes me worried.
Silver Linings Of A Stock Market Correction
1) A catalyst to finally learn about risk management. If you’ve only been investing since 2009, the path towards building stock market wealth has been relatively straightforward. I argue its been too easy for the 35 and under generation to build wealth, thereby creating a false sense of security. Being overconfident in your investing abilities can be devastating once you’ve accumulated a large nest egg.
See: Recommended Net Worth Allocation By Age
2) The ability to accumulate stocks at lower valuations. The keyword is “valuation,” and not price. If the price is lower by 10%, but earnings are cut by 10%, then you’re paying the same valuation for a stock. But if prices move 10% lower and earnings come out the same, then you’re getting yourself a deal.
The consensus 2018 S&P 500 earnings estimate is ~$155 (+17.8% from 2017). Therefore, at 2,500 on the S&P 500, the market is trading at a reasonable 16.1X forward earnings vs. long term average of ~15X. The consensus earnings expectation for 2019 is for earnings to grow by another 10% to $171, or 14.7X 2019 earnings.
The trillion dollar question is whether earnings will grow as expected, fall short, or exceed expectations. Valuations are generally considered “reasonable” if the P/E to Growth ratio is around 1X e.g. 15X P/E and 15% earnings growth.
Except for the rise in the 10-year bond yield to 2.85%, there was no other fundamental news that wasn’t already out there that could drastically affect earnings. Therefore, at the moment, it looks like investors are getting a valuation discount. And from a bond investor perspective, you’re receiving higher yields.
3) It takes time for corrections to play out. According to analysis by Goldman Sachs, since WWII the average correction is -13% over a course of four months. It then takes an average of four more months before the S&P 500 recovers all its losses. In other words, don’t use all your dry powder all at once if the stock market is down 10%+ in just a couple weeks. Rather, leg in through multiple tranches because timing the market is too difficult.
If you have a long-term mentality, you’ll be able to better contain your rush to sell and rush to buy.
4) A return to humility. Every time I write an article about investing, without exception, there will inevitably be someone who comments or e-mails saying how much money they’ve made in the stock market or how they timed a trade perfectly. Over social media, we witnessed a phenomenon of older folks bragging about their $1,000,000+ 401(k) balances. And younger folks love to shout from the top of their lungs how much they make every month online. After a while, this starts to get old.
Financial writers, like yours truly, will also begin to write with more humility. A downturn helps remind me that the focus of Financial Samurai is on learning so we can become better investors, better partners, better citizens, and ultimately happier thanks to the freedom money buys. My finances are used for illustrative purposes only because nobody should give a damn about my wealth except for my family.
As investors, it’s important to constantly remind ourselves that over the long run we are not smarter than the market. We must not confuse brains with a bull market, nor should we confuse stupidity with a bear market.
5) You don’t feel as bad selling risk assets too soon. One of the most difficult things I had to overcome when selling my SF rental house was accepting that I was probably selling too soon. In my mind, owning San Francisco real estate is a multi-decade no brainer. But I couldn’t take being a landlord anymore, especially after rents fell 10%+.
After I sold in mid-2017, the stock market continued to go up. To not be left behind, I re-invested my house sale proceeds into stocks, index funds, muni bonds. and real estate crowdfunding. But I took $815,000 in exposure off the table by wiping out a mortgage.
Now that the stock market is going through turbulent times, I feel great having sold. I’d be more stressed out today if I held, knowing that I passed on a great offer worth 30X annual gross rent, received less rent, and had to deal with maintenance issues and problem tenants.
Related: Investment Ideas For Reinvesting The Proceeds Of Your House Sale
6) You feel great holding cash. Despite reinvesting my house sale proceeds, I still was left with about $300,000 of cash (out of $1.8M) plus a 3% yielding CD worth about $184,000. When the markets are going up, you feel bad that your cash is earning you practically nothing. But now that the stock market is going down, having lots of cash feels like the best thing ever! It feels amazing to have an asset that doesn’t lose money.
After the S&P 500 corrected by 10%, I deployed half my liquid cash stash. I plan to deploy the other half if the market corrects by another 10%. With interest rates up, I can easily find a new risk-free home for my CD proceeds with the same rate. Cash management is all about stress management!
See: In Times Of Uncertainty, Take Stock Of All Your Cash
7) A chance to finally build your long shot. If it wasn’t for the 2008-2009 financial crisis, Financial Samurai would never have been born. Without Financial Samurai, I wouldn’t have been able to have as much carefree freedom as I have today.
The downturn made me fear for my job and my wealth so badly that I finally decided to do something about my fear. We’re nowhere near financial crisis-level panic today, but the correction that began in February 2018 reminded me of the stress I felt 10 years ago.
If you depend on only your job and your investments to keep you financially secure, a violent correction is the perfect time to start brainstorming new ways to make money.
Yes, it helps to whip your spouse into working harder and longer so you can just relax. However, spouses sometimes also could lose their jobs and investments.
For most people, investments should be considered a tailwind for financial growth. Building a business where you own most of the equity is how you can build next level wealth. It’s harder to get rich working for someone else.
But if you don’t want to venture into entrepreneurship, do well at your job. Get regular raises and promotions and aggressively save and invest for the long term.
A Refocus On What Matters Most
If you are not careful, a stock market correction can suck up all your time. It can make you a little crazy. During one of the -4% days I realized I was already on my computer for 2.5 hours straight watching the markets burn. I was reading everything I could about the why, the what next, and what to do. Don’t let a stock market correction take over your life!
Once I realized my glued obsession, I shut my laptop. Then I went downstairs to see my wife and son, gave them both big hugs and kisses and started to play. After all, the point of financial freedom is to not worry about money.
In 20 years, this correction won’t make a lick of difference. Don’t forget to enjoy your life during the process. If you need me, I’ll be finishing up my underground bunker just in case the world comes to an end.
Recommendation To Build Wealth
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After you link all your accounts, use their Retirement Planning calculator. It pulls your real data to give you as pure an estimation of your financial future as possible using Monte Carlo simulation algorithms. Definitely run your numbers to see how you’re doing.
I’ve been using Personal Capital since 2012. As a result, I have seen my net worth skyrocket during this time thanks to better money management.
My silver lining is remembering that I’m not too late to the market. I just gotta get in and stay in and things will change.
With all that free money out there, I believe that corrections will have a very short-term recovery.
Of course, all bets are off if inflation (therefore rates) increases.
I’ve written about this in my 2018 Investment Outlook. Only:
– Inflation or;
– Major world-wide event.
Can cause a bear market.
Now is a great time to invest in things that bring immediate and short term returns, like paying off debt! As we await the likely market correction, paying off debt now will free up future cash for when stocks are at a more attractive price. Not only does this eliminate your debt quicker now, but you’re be poised to jump on the great opportunities available in a down market!
I agree with all of this! I’m definitely going to hold on to cold hard cash a little more tightly this time. It will be nice that at least with that I’m not losing money even though there’s a stock market correction going on. But it may also be a great time to buy but gotta spend hours of research to find great picks. I totally understand how you can get so obsessed with the market. When I started investing, I used to freak out over the smallest dips and even now I find myself researching for hours on some of my investments. Thank you for this post and for a reminder that there are more important things in life than money, it was a great read!
Mrs. Groovy and I went into 2017 with an asset allocation of 35% equities and 65% bonds/cash. With that allocation, our returns were obviously below the S&P 500. But because of our one individual stock, a lithium mining concern, our returns weren’t horribly below the S&P 500 (16.9% vs. 22%). Anyway, we went with such a conservative allocation because last year was the first full year of our retirement, and we don’t want a 2008-like crash in the first few years of retirement to destroy our retirement plans. So we’re itching for the next bear market. I know that sounds sick, but we have a lot of dry powder to take advantage of such a calamity. Great post as always, Sam. Cheers.
Sam, what did you invest your first tranche in, S&P Index?
At about 750 in 1997.
Just in case any of you younger folks read Sam’s initial entry point into the S&P 20+ years ago and think you’ve missed the boat, just a reminder that historical returns of the S&P for the last 100 years WITH dividend reinvestment (very important for compounding returns!) is 10.4% (feel free to check for yourself at https://dqydj.com/sp-500-return-calculator/). Using the rule of 72 (if you don’t know it you MUST Google it!!), the S&P would double roughly every 10 years, equating Sam’s entry point to an S&P of 3,000 today. Just to be clear, that doesn’t necessarily mean that the S&P is currently undervalued (although in a lengthy comment I provided earlier, I think valuations are very reasonable right now for LONG TERM investors (10+ year time horizon); just wanted to share my opinion for you younger investors that you haven’t missed the boat by any means – your biggest asset is what so many of us wish we had more of…TIME…use it to your advantage!!
I plan to buy in dips. I’m grateful for the correction being a long-term investor, lol.
On another note, I came across an interesting post on Rockstar Finance where a writer dove into how investing a lump sum is more favorable than DCA – and that’s making me reevaluate when I should strike.
The silver lining is that I can watch and l̶a̶u̶g̶h̶ learn from them who don’t know what they’re doing. How else are you supposed to learn from those who don’t know what they’re doing?
I don’t see a “cloud,” so I don’t see the need to find a silver lining. This is just normal stock market movement.
Great post, I like the tone it is written in. Yes being FI should take these worries away and allow you to enjoy more important things in life. For me this was a bit of a wake up call, but I believe in 10 years from now this will only be a blip on the radar. If you take an S&P 500 graph and filter for the maximum period you can not even see the corrections of 30 years ago
The way I look at this market is I think the market is re-balancing the same way you re-balance a portfolio from 70/30 to 60/40. I think we narrowly missed deflation through Fed manipulation and the 9 year bull was simply movement into more risky assets, not truly a bull. As bonds rates and interest accounts rise pressure will come off on stocks and growth in equities will be lower as money moves to safety. That’s not a bear market, it’s a return to normal allocation across asset classes. Re-balancing reduces risk and improves diversity, both very desirable. The way you make money is to reduce risk and diversify so your portfolio behaves like the market.
Here is a silver lining: Re-allocation is a great time to tax loss harvest if you have money in post tax accounts!