Understanding Stock Market Corrections and Crashes
Investing involves risk. Any investor that has invested in stock markets longer than five years knows that because they have experienced the ups, downs, and all the volatility in between. But, why would you want to endure all of that uncertainty in the first place? The reason is that we expect markets to go up over time, and historically that has been the case. Even so, history has delivered countless reasons to avoid investing in the stock market and there is no guarantee that markets will continue to go up in the future. From the crash of 1929 to World War II to stagflation of the 1970s to the 2008 financial crisis, staying invested for the long-term has been no easy task.
In spite of all of the stock market crashes and corrections, if you invested $100 in the S&P 500 at the beginning of 1926, you would have about $1,264,161.11 at the end of 2021, assuming you reinvested all dividends. This is a return on investment of 1,264,061.11%, or 10.34% per year (excluding fees and taxes). It is incredible to witness this upward trend. But, markets do fluctuate along the way. Even for experienced investors, the turbulence can be a little scary because you can't know how far the market may fall or how long it will be before it may rebound. We are currently in a period where there is a lot of stock and bond market volatility and economic unknowns. As a result, you might be asking yourself,
- Is the market crashing now?
- What's the difference between crashes and corrections?
- How often do stock markets crash or correct?
Some historical perspectives may be constructive as you search for answers. Let's look at how stock market declines, crashes, and economic busts have played out in the past. History never repeats itself but it certainly does rhyme and you may find comfort in understanding historical market trends to have a better benchmark for future comparisons.
With that, here is everything you have ever wanted to know about stock market corrections and crashes.
Market Corrections Versus Crashes
Before we start, there's something you should know: any time the market declines, media and news outlets jump on the opportunity for a click-worthy story. Now, this "story" doesn't always make it easier to understand exactly what is happening. Because people use these phrases so often (and sometimes interchangeably), let's make sure we know the difference between a market crash and a market correction.
- Correction-There isn't a standardised definition, but the commonly accepted definition of a correction is a drop of more than 10% but less than 20%.
- Crash-A decline of 20% or more.
People often refer to a decline of less than 10% as a dip or pullback, and the difference comes down to a matter of degree. So when you are wondering what's happening to the market, just be sure to ask, How deep is the decline? Your answer will help point you in the right direction!
How Often Does The Stock Market Crash?
Now that we have clarified what these phrases mean, let's dig into the nitty-gritty. A market crash is the most detrimental to investment portfolios and potentially, your lifestyle, so let's start there. Contrary to some people's beliefs, market crashes do not follow predictable patterns. So don't take this commentary to mean we are trying to tell you that they do. We are simply providing you with historical data to show how frequently (or infrequently) crashes tend to occur. Since 1950, the S&P 500 index has declined by 20% or more on 12 different occasions. The average stock market price decline is -33.38% and the average length of a market crash is 342 days. However, and this part is critical, the bull markets that follow these crashes tend to be strong and last much longer. The market recoveries dwarf the crashes both in terms of severity and duration.
How Long Does A Stock Market Crash Last?
A true market crash, as opposed to a dip or correction, can be brutal. The average bear market cuts stock prices by 36% from peak to trough and these declines typically last over a year and a half. And stock market recoveries are even longer, taking almost two and half years on average. To put this in perspective, the stock market recovery from March of 2020 took only 6 months. S&P 500 peak to trough declines of 20% or more since World War II.
How Long Does A Stock Market Correction Last?
Corrections are softer than crashes, which is why they have a more gentle name. But that doesn't mean you won't feel them. There have been 24 stock market corrections since World War II and the average correction sees the market drop by 14.3%, which can be painful. Not only are corrections more minor than crashes, but they are also more gradual, too. It typically takes five months to reach the "bottom" of a correction. However, once the market starts to turn, it can recover quickly. The average recovery time for a correction is just four months! That is why investors with truly diversified portfolios may consider staying investing for the long-term. If you get out, you may miss the subsequent recovery which can be devastating to your portfolio.
How Often Do Stock Market Corrections Occur?
Corrections occur more frequently than crashes. On average, the market declined 10% or more every 1.2 years since 1980, so you could even say corrections are common. Again, it's not clockwork, but that should help you put things in context when the market drops.
When was the last stock market correction?
You may be surprised to know that we've already had one stock market correction in 2022. While we did not experience a stock market correction in 2021, we experienced five stock market corrections in 2020 alone! Smaller stock market corrections happen even more frequently. Just about every year since 1980, the market has experienced a temporary decline of 5% or more. On average, a 5% decline in stock market prices has occurred 4.5 times a year over the same period.
What Should I Do About Stock Market Crashes and Corrections?
First, you need to understand that they will happen. If you want to know how to identify a stock market correction in advance, don't spend too much time. They are unpredictable. And, they are driven by a different set of events every time.
Secondly, you should make sure that your investment portfolio is designed to withstand only as much risk as you are willing to endure. Once you de-risk your portfolio, weathering a stock market crash or correction may be a bit more palatable. But, it still won't be easy.
Thirdly, there are steps you can take once a recession or stock market crash occurs.
Your investment plan should be tied to your goals and balanced to allow you to remain focused on goal achievement. That means your asset allocation (the right mix of stocks, bonds, and cash) should be aggressive enough to provide the long-term return you need but conservative enough, so you don't panic and change course when the market dips, corrects, or crashes. Understanding the nature of market declines-how frequently they occur, their severity, and how the market rebounds after-can help you avoid common investment blunders.
Ups and Downs Are Part of The Deal
As you know, markets aren't stable or steady over the short term, but they tend to perform consistently well over the long term (again, there is no guarantee). That's why it's so critical to adhere to an investment strategy with a long-term focus and structured guidelines for implementation. Unfortunately, many investors don't have the right investment strategy in the first place. That's a major problem because when stock market crashes and corrections do occur, they can result in substantial losses and anxiety if you aren't careful. That's where hiring an expert may be helpful. We specialise in helping expats craft personalised investment portfolios that support the life they want to live in a sustainable, tax-friendly, and risk-managed way. So before you alter your strategy to match the markets, remember, there's no beating, timing, or guessing the markets. What you need to have is a disciplined, concerted strategy that gives you the best chance of weathering stock market corrections and crashes.
If you are interested in learning more about how we can help you, contact us - firstname.lastname@example.org - to craft an investment strategy you can count on.