Yellowstone Financial, Inc.

What the Stock Market Correction Means to You

As I write this, the S&P 500 US large company stock index is down 1 percent year to date.  This fact alone would point to a somber yet somewhat sleepy start to the year.  Of course the reality has been quite a bit more turbulent.  For the first time in history, the Dow Jones plunged more than 1,000 points in a single day on February 2nd.  It managed a similarly dreary performance three days later.   With these recent declines in mind, consider these steps to make sure your portfolio is positioned to support your future goals

Stock market corrections are normal.  Let’s face it.  We had grown accustomed to the stock market hitting new highs every week.  Before the recent market doldrums, it had been two years since the last stock market correction.  A correction is defined as a 10 percent decline in a market index such as the S&P 500 from a recent high.  We traditionally have seen corrections on average once a year including more recent ones ending in 2010, 2011, 2015, and 2016.

A smartly diversified stock portfolio can go up or down from one year to the next.  But once you get into at least five year holding periods, recent history has shown that you have a high likelihood of ending with a portfolio higher than when you started.  To help you remember the long game, consider the S&P 500 index now at around 2,650.  Now use Yahoo Finance or another service to look up its value on your birth date.  In 1960, the index was trading at about 55.  So over 58 years the S&P 500 has increased by 48 times, not including dividends.  Increases over time of that magnitude far outweigh the ups and downs from one year to the next.

The best risk tolerance test is the real thing.  Whenever we recommend an investment strategy, we describe how it performed during one of the worst bear markets in our lifetime: the 2007-2009 Great Recession crash with its 57 percent S&P 500 decline.  A bear market is defined as a 20 percent decline from recent highs, so this is an extreme example.

We’re not trying to frighten our clients, but are doing our best to simulate what the worst conditions can do to a portfolio.  We can fill out risk tolerance questionnaires until we’re blue in the face, but it won’t tell us how you will react during the next downturn.  While this recent correction was fairly mild in the context of bigger swings a decade ago, it does give us a taste for a quickly declining market.

The worst investment strategy is one that grows more conservative as the stock market declines.  An important component of having your financial health thrive in all markets is the ability to purchase what is cheap and sell what is expensive on a regular basis.  Yet most of us have the opposite response when stocks get cheaper.  So reflect back on how you felt during the recent market decline.  If you felt panic, you may want to increase secure investments such as bonds in your portfolio.  Otherwise you could be setting yourself up for some panicked stock selling in the future.

Adjust your 401(k) contributions for tax changes. If you’re like most taxpayers, you have an effective pay increase now that new tax withholding tables are being used with the passage of tax law in December.  Consider increasing the percentage of your pay that goes into a 401(k) or other work retirement plan.  With the tax cut, you won’t feel the pain in your checking account and you’ll increase your investing after a market decline. 

Ignore the Dow and big point moves.  Longtime readers know that the Dow Jones Industrial Average is a flawed measure of stock market performance as it’s an antiquated average of the stock prices of 30 companies.  As an example, Boeing with its stock price near $350 has a weight in the Dow more than 4 times that of ExxonMobil priced near $75, even though the latter is worth more as a company. The Dow serves best for historical purposes rather than an accurate measure of US large company stock performance.  Pay attention to the broader S&P 500 and Wilshire 5000 indices for domestic stocks.  And don’t get riled up with the big point losses (or gains).  Keep the percentage gains in mind for true perspective.