Here's What to Do When a Market Correction Threatens Your Portfolio

A market correction could rear its head. Here's what you should do next to coach your portfolio through the dip. It will help you know how to handle y...

By Melissa Brock contributor/ via MarketBeat

This story originally appeared on MarketBeat

Have you enjoyed the bounceback on Wall Street since March 2020? Who hasn't?

However, experts at Moody's say we could be in for a market correction to the tune of a 10% to 20% pullback. The recovery may be slow as well — it could take a year to return to the break-even point.

So, what will you do? Forget panic selling. You know better. Here's what you need to know and how to handle your investments.

Tip 1: Buy the Dip

Yes, we're starting with "buy more!" because especially if you're a novice investor, it might not occur to you to buy when the market shifts. You might just worry about keeping your investment afloat. However, you really want to arm yourself for the future by buying in the present. When the bear starts sniffing around, buy more… bear spray.

Buying the dip means you buy assets at a cheaper price to take advantage of "buy low, sell high."

A few tips for buying the dip:

  • Check into a company's fundamentals so it's more likely to appreciate when the market rebounds.
  • You can't know how far the company's shares will drop, so know that you won't know exactly when to buy the dip. However, buying the dip when you know it's happening means you can still make money later.
  • Think value investing. You buy underpriced stocks that trade below what the company is worth in the long run.
  • Consider certain types of industries that might jump later: technology, communications, growth stocks and cyclical stocks. Consider those industries that become ultra-sensitive during a downturn.

Don't forget to research the underlying trends in earnings growth, company strength, debt-to-equity ratio, price to earnings ratio and company leadership so you choose the right stocks when you buy the dip.

Tip 2: Take a Look at Your Goals

Remind yourself of why you're investing. Is it for the long term, such as for retirement? Are you saving for a short-term goal, like a new patio or pool?

Knowing your goals will help you when a market correction rears its head and can help you make decisions when a market correction comes.

You may want to avoid a single sector during a market downturn, especially if you have a short time horizon for which to build your savings. For example, let's say you're heavily invested in retail, restaurants or travel and tourism. We know those sectors usually get hit hard during a recession, and the COVID-19 pandemic was no exception.

The quick fix: Add to your portfolio if you have a short-term time horizon. Diversification will fix these problems, especially when you know specific companies and industries may bear the brunt of a downturn. Try adding fixed income and commodities instead of just equities, for example, to balance your entire portfolio.

On the other hand, let's say you're planning to retire in a year. Check your allocations to make sure you're not heavy-handed in one specific sector. Or if you're heavily invested in just stocks, for that matter. Add a few bonds to the mix to balance it all out so you don't have to delay your retirement.

Also, understand your risk tolerance like you understand your love for cherry cheesecake. It will help you know how to handle your short- and long-term goals and how comfortable you feel when the market dips.

Tip 3: Rebalance Your Portfolio

Lots of things get out of whack — your car tires, your hip, your portfolio. What do we do to fix those things? You rebalance (or in the case of your hip, you go to the chiropractor).

How do you rebalance your portfolio? You monitor your investments and determine which stocks are ailing. In other words, let's say you have an aggressive portfolio of 70% stocks and 30% bonds. Let's say that with the market dip, stocks have dipped to make up just half of your portfolio. You may want to sell bonds and buy stocks to get back to your preferred ratio.

Tip 4: Hang on Tight

You probably already heard this before, but keep on, keeping on with your portfolio. Never forget Warren Buffett's rule of thumb: Rule No.1: Never lose money. Rule No. 2: Never forget rule No.1.

What happens when you sell low? You lock in losses. Buying low can send your accounts on the up and up but selling low ruins it. The most important thing you can do involves keeping what you have and making small changes so you can put yourself in a better position when the market corrects.

Tip 5: Consider Value Stocks

Investing in value stocks was one of the tips mentioned above. However, it's a good tip to go over again. Value stocks have proven to perform better during down periods in the market, particularly during early stages of an economic recovery.

Value investing involves finding stocks undervalued by the market. Most value investors use financial ratios such as price-to-earnings, price-to-book, debt-to-equity and price/earnings-to-growth to unearth these types of stocks.

When economic growth slows, growth stocks can't go any higher, so value stocks whip through the down market and have just one way to go — upward.

The Tough Get Prepared

Market corrections can bring about a major moneymaking opportunity. You don't have to wait for another recession before you take advantage of it.

Also, remember this one last tip: It's perfectly normal to want to wait for that "absolutely perfect" stock price when you're on the hunt for cheapies during a downturn. However, you never, ever know how long the downturn will last and how steep it'll go. Don't miss your opportunity completely and try to time the market. You could miss out on great opportunities because you say to yourself, "I'll just wait for that next 5% drop. Or the next 10%."

The next day, that stock could jump back up to its original price — or zip to greater heights.

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