Because they keep bubbles from forming – but only if you’re prepared

With the stock market’s historic growth that began in early 2009, many believe a 10% pullback may be a healthy thing. Such a drop is not horribly painful, by historical standards, and smart investors can cushion such a fall.

Why is a market correction healthy and beneficial? Because it prevents another bubble from forming. Bubbles occur when stock prices get clearly out of line with the earnings potential of the underlying companies. We saw the consequence of that in the 2000-02 and 2008-09.

Certainly, market corrections never feel healthy when they occur. People get fearful as the market declines, the media fan the flames by giving investors reason after reason to be afraid, and worries that this is the beginning of the next crash begin to develop.

While many investors admit that a 5% pullback is manageably unpleasant, concerns expand when the market decline hits 10%. That’s what customarily constitutes a correction. In the most recent sell-off, from January 26th to February 8th of 2018, the Standard & Poor’s 500 index fell 10.2%. We just crept into correction territory, but since that time, the market rebounded and now trades above its early February level.

Author and money manager Ben Carlson looked at the S&P data going back to 1950, and found 28 time periods when stocks fell by 10% or more. Thus, on average, the market has entered an official correction every 2.25 years. The last market correction occurred in early 2018, but another 10% drop in the near future is not unreasonable.

The average post-1950 market correction lasted just under eight months and the median total loss was 16.5%. What about deeper declines?

Of the 28 times the S&P 500 decreased by 10% or more, the market suffered a loss greater than 20% – the standard definition of a bear market – only nine times (32% of the time), and a loss greater than 30% only five times (18%). The data confirm that, although these types of large losses do occur, they really are the exception.

Can you Stomach a Correction?

A capable financial advisor ensures you have an asset allocation mix that represents your values, goals, time frame, and your over-all financial picture. But more importantly, a good financial advisor makes themselves available to provide a listening ear to hear if anything has changed in your life to affect your personal financial plan. A good financial advisor provides a timely reminder of what’s important to you and what you can control.

Although the recent market pullback might create anxiety, media headlines and possibly fear, remember this: we’ve been here before.