When the market drops, it's important to not lose perspective and understand that downtrends and uptrends are part of the investing cycle.
Fact Checked byTaylor Hegna, CFP®
It seems like a silly question to ask, but in fact it is a real issue to discuss. When the market drops, some investors lose perspective that downtrends and uptrends are part of the investing cycle. When stock prices break lower, it's a good time to review common terms that are used to describe the market's downward momentum.
A pullback represents the mildest form of a selloff in the markets. You might hear an investor or trader refer to a dip of 5-10% after a peak as a "pullback." (1)
The next degree in severity is a "correction." If a market or markets retreat 10% to 20% after a peak, you’re in correction territory. At this point, you’re likely on guard for the next tier. (2)
In a bear market, the decline is 20% or more since the last peak. (2)
Pullbacks, corrections, and bear markets are a part of the investing cycle. When stock prices are trending lower, some investors can second-guess their risk tolerance. But periods of market volatility can be the worst times to consider portfolio decisions. Pullbacks and corrections are relatively common and represent something that any investor may see from time to time in their financial life (often several times over the course of a decade). Bear markets are much rarer. In fact, between April 1947 and September 2021, there have only been 14 bear markets. (3)
Two main areas that get people nervous when markets start to trend downward are their income needs and how their specific financial plan will respond.
When we are young and working, the ups and downs of the market don’t hit as close to home. When we are approaching the final leg of our working careers or are retired, even small market drops can feel like a shockwave if we are uncertain about how it impacts our timeline and our ability to meet our financial needs without a steady paycheck.
The key to managing anxiety with fluctuating markets can often come down to how our income in retirement has been designed.
For example, when you transition out of a career, the money we have saved is designed to replace our paychecks, but where do we start to pull dollars from? If your original plan was to retire and start drawing from your retirement accounts rather than turn on Social Security, could you do the opposite if the market was trending down? This will allow us to let our investments rebound while securing an income stream and perhaps still retire at the same time as before.
Another option could be setting a portion of our retirement dollars in a low volatility portfolio so we are not feeling any big swings as we draw income.
The great unknown of how far our accounts could drop is never a fun space to reside. When we don’t know how our accounts will respond, it becomes natural to assume the worst. However, a properly balanced financial plan allows for us to not feel all the pain of a downward trend, although it also means we don’t receive all the reward of an up market. As investors, we cannot have the best of both worlds. That mindset can be detrimental to successfully managing both our emotions and expectations.
Technology today allows for specific investments to be tested against various market conditions and historical markets. By seeing these results first-hand we can have a clear view of what the potential future may hold. Better to have an idea than to let our imagination run wild!
At the end of the day, no one has a crystal ball to tell us where the markets are headed. That is why we need to have a plan that provides for our needs - and hopefully accounts for our wants - in good, bad, and even ugly times. Performance may vary but a plan can help you adjust.
If you have questions about creating a plan to help manage the ebbs and flows of the market, reach out to us today!
1. Investopedia.com, August 23, 2021
2. Investopedia.com, September 20, 2021
3. Investopedia.com, October 29, 2021