Personal Finance - Arla Wallace
Arla Wallace is an accounting professional with over 20 years experience. She spent several years working for both publicly-traded and private entities before founding her own business. Today she partners with small business owners so they can focus on operations while leaving the responsibility of staying on top of accounting tasks to her. She is a Certified Public Accountant (CPA) and a Certified ProAdvisor for Quickbooks Online.

Individual Investment Portfolios:  Weathering Market Corrections

Individual Investment Portfolios:  Weathering Market Corrections

Individuals with a competitive talent have a desire to win. Those individuals continually seek to measure progress against the performance of others. Losing, while frustrating, is an opportunity to make the necessary adjustments and compete again. The same can be said of investors and the stock market. Trading benchmarks make it possible to compare differing equities to measure performance and progress. Market corrections occur when there is an economic shock or a major societal event that prompts investors to consider what’s happening in the world. In order for investors to weather these market corrections and minimize market losses, there are steps that can be taken before and after a market correction occurs.

Before a Market Correction

The first step investors should take before a market correction occurs is to build an investment portfolio. An investment portfolio is comprised of assets that include stocks, bonds, cash, and other securities. Individual portfolios are typically built on where an individual currently is financially, and where they hope to be when the portfolio is created. The “100 minus age” rule is a general guideline that is used by investors to determine the mix of stocks and bonds in a portfolio. Under this rule, an individual determines the percentage of stocks to hold by subtracting their age from 100.

The next step investors should take entails assessing their individual sensitivity to the market. This allows an investor to remain in equities, but reallocate their investments to match their established level of risk tolerance, or account for changes in their investment timeline, or changes in an individual fund’s performance. Beta is a measure of a stock’s risk relative to the market as a whole, and includes both business risk and risk associated with taking on more debt. A security with a higher beta comes with a greater risk but higher expected returns. Investors can use beta to make sell decisions or to lower the risk of individual equities in their portfolio. Securities with beta greater than one have more volatility than the market as a whole, while securities with a beta less than one have less volatility than the market as a whole.

After a Market Correction

A market correction is a market decline of more than 10%, but less than 20%, of a major stock index from its most recent peak. A bear market is typically defined as a decline of 20% or greater. Market corrections have historically returned stock prices to longer- term trends. Such corrections have lowered the stock prices of some companies to levels that are considered undervalued. Following a market correction, investors can consider further adjustments to their individual portfolio, such as using strategies that are typically profitable with a stock market decline. Another option is to adjust the portfolio back to where it was before a correction. This is done by reversing the allocations made in preparation for the market decline. A third option is to add more money to an individual portfolio. This may include picking up assets at a relative discount, possibly leading to better returns if the market returns to levels prior to the correction.

Although market corrections are unpredictable, they are fairly common. Being prepared at differing life stages by having a financial plan in place, determining your personal risk-level tolerance, and reallocating investments as necessary can help your investment portfolio weather the next market correction.