Investing in stocks isn't for the faint of heart. That's because the stock market has the potential to swing wildly from one day to the next. And over a period of time, it's more than possible for your portfolio to lose value due to changing stock prices.
In fact, your portfolio might take a more serious tumble during a stock market correction. So it's best to know what to do -- and what not to do -- when a stock market correction hits.
What is a stock market correction?
A stock market correction refers to a period when a broad market index, like the S&P 500, loses more than 10% of its value but less than 20%. And there are different factors that have the potential to lead to a stock market correction.
A recession, for example, can cause stock values to drop as investors lose confidence in the economy on a whole. And sometimes the market can simply overheat.
When stock values climb continuously, after a period of time, investors might come to the conclusion that those companies aren't worth as much as the market seems to think they're worth. Investors might then start to pull away from the market, leading to a drop in stock values.
It's not always possible to predict when a stock market correction will hit. But there are often warning signs, like rising unemployment rates and seeing too many stocks that are overvalued.
How to avoid losing money during a stock market correction
Some stock market corrections are short-lived. Others can last longer.
During a stock market correction, you might see your portfolio lose quite a bit of value. For example, if the broad market is down 15% and you have a $100,000 brokerage account balance, during a correction, the value of your portfolio might fall to $85,000. And that can certainly constitute a tough blow. But one thing you must remember is that if you don't sell off stocks when their value is down, you won't lose money.
In our example, an $85,000 portfolio balance represents the value of your holdings at a single moment in time. If you leave your portfolio alone and ride out a stock market correction, you may find that your balance is back up to $100,000 in seven months, and that it's up to $105,000 a few months after that.
In fact, over the past 50 years, the stock market has undergone 28 corrections. And guess what? It managed to recover from every single one.
As such, your best bet is to simply leave your portfolio alone during a stock market correction. Doing so could be your ticket to avoiding losses.
That said, there is one change you should feel free to make to your portfolio during a stock market correction, and it's buying new stocks if you can afford to. Stock prices tend to get discounted during a correction, which gives you a great opportunity to add valuable assets to your portfolio without having to pay what they'd usually trade for.
As an example, if there's a stock you'd like to own that normally trades for $100 a share, during a correction, you might be able to scoop it up for $85 a share. So the advice to leave your portfolio alone during a correction mainly applies to selling off stocks, not buying new ones.
All told, stock market corrections are fairly common, so it's best not to panic over one. Just remind yourself that the losses you're looking at aren't permanent, and that might help you maintain a positive outlook during an otherwise challenging time.
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