The following is adapted from the book, Keen on Retirement – Engineering the Second Half of Your Life.
If you’re going to have a comfortable, smooth entry into retirement, you have to be able to afford to retire in the first place. In addition to Social Security, most retirees rely on IRA accounts and investments to fund their golden years. While investments can often yield the greatest profits, they are not without their share of ups and downs.
When the market takes a drop of more than 10 percent, this so-called correction can be scary. But knowing that you must ride out stock market corrections is key to fueling your retirement account. Here’s an introduction to market corrections, why weathering them is so essential, and how not to panic when a correction occurs.
The Ebb and Flow of the Stock Market
If you look at a chart of the US stock market volume, you’ll notice that overall there is an upward trend since the start of the century. In fact, this curve is huge, as measured by the Dow, or the Dow Jones Industrial Average.
The Dow is a stock index that measures the performance of a few dozen key American stocks, which are used as indicators for the overall health of the market and the US economy. Even though the Dow may take huge hits, often in response to global political events, history has shown us that it will go back up again.
Often, the stock market drops because of an event like the 9/11 attacks or a change in political leadership. Sometimes it will undergo a correction which is actually an appropriate response to an uptick in market prices that can’t be sustained.
There are short-term and long-term corrections. Just about every year, the market sustains a significant dip before heading back up again. Roughly every 30 years, there is a major correction, where it takes the market longer to rebound. So far, no one has developed a formula or algorithm for reliably predicting market corrections.
The Problem With Corrections
Stock market corrections can be horrible to experience–especially the larger ones–and waiting for the market to recover can be fraught with concern. But we know historically the market always improves.
Meanwhile, it’s tempting to check the market all day long hoping for an improvement. It feels like you’re being proactive and responsible, but it’s bordering on obsessive worry.
When we don’t see things getting better, it’s easy to imagine that this time, the market really won’t recover. When this gloomy thought persists over time, some people get the idea that they should bail on the market, selling their stocks, often at a loss.
How to Prepare for Market Corrections
So, if you’re planning for retirement or already retired, how do you deal with a market correction? First, hold tight to your investments and ignore the urge to sell, unless a financial advisor you trust implicitly helps you to make a smart rebalance.
Second, maintain a fixed, stable income you can live on until the market rebounds: a paycheck, Social Security, bonds, or other revenue you can count on. You can use these funds to carry you through until the market recovers, even if that’s five or more years down the road.
You should also have a balanced portfolio, meaning investments in more than one company and more than one economic sector. Should one area tank, it won’t bring down your entire portfolio.
When you’re prepared for market corrections, not only can you ride out the storm, but you can also have the benefit of buying new investments at a low price, taking advantage of the correction. Then, when those stocks grow, you can move any profits you may have made into a more stable part of your portfolio.
For more advice on weathering stock market corrections, you can find the book, Keen on Retirement on Amazon.