Ugly truth: Volatility is going to be turbulent for the rest of 2022 so what should investors do to keep their nerves while the sharks are circling?
The ASX stock market is likely to experience several corrections this year. The 10-20% decline in the price of security often causes panic amongst investors. However, a market correction can also present the best opportunities if you know how to objectively deal with it.
Fact: Personal biases may affect an investor’s ability to make sound judgments during a stock market correction. Don’t fall into that trap and get into a defensive position. Most importantly, stay calm and don’t make sudden movements.
Negative returns in shares are a normal part of the investing cycle. The good news, though, is that the market always recovers. In fact, the global stock market has posted gains of around 55% of trading days since 2010. Remember, a bull market can last for nine years and a bear market may only last for one so in all likelihood, market corrections while ferocious, are not eternal.
Here’s our survival guide when faced with an ASX stock correction.
Start Building a Diversified Portfolio
To stabilise your returns, we recommend you access a broad range of assets, including bonds, shares, commodities and cash. Make sure to invest in asset classes that don’t move in tandem. According to Elton and Gruber’s book Modern Portfolio Theory and Investment Analysis, a diversified portfolio can be achieved by owning at least 20 stocks, bringing down the risk to less than 22%. Impressive.
Another way to reduce the risk is to use the Dollar-Cost-Averaging method where you divide the total amount of your investment across periodic purchases. Simple yet effective.
Keep an Eye on the Target and Don’t Dismiss Your Long-Term Plan
As Warren Buffett puts it, “If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes.”
We see it every day when amateur investors immediately rush for exits during a correction, resulting in an actual loss instead of just paper losses or reduced profits. They sell at any price to alleviate the pain of losing – this is called myopic loss aversion wherein in the attempt to avoid immediate pain, you are willing to sacrifice future gains.
It’s easy to get affected by the market noise, but it’s best not to listen. Monitor your portfolio regularly but we don’t suggest doing it every day. Other experts don’t recommend watching the stock market news during a correction so instead perhaps focus on the quality of your shares and assess how these will perform in the coming years.
Remember when the ASX 200 slumped from 7000 points to 4816 points in March 2020? Most investors believed it was an awful step to keep or buy shares at that time, it was like an apocalypse with a sea of red. However, those who chose a contrarian strategy continue to reap rewards today.
Being still and patient is the key.
Perhaps a safer strategy prior to a market correction is to lock in some profits whilst preserving the principal amount.
Important Note: Get rid of speculative stocks that you are not confident to keep in the coming years.
Stop the Bargain Hunting and Take Note of the Blue Chip Companies
Another typical reaction is to spend too much on random stocks without doing your due diligence and this is just as bad as impulsively selling your shares. Trendy investments like NFTs gave us impressive graphs, but you need to step back and identify which shares matter to you in the long run.
If you plan to buy, opt for blue chip shares or companies with good cash flows and strong dividend stocks over companies that depend on future growth. We’ve recently rounded up the top 5 ASX Companies to buy for capital growth in 2022. You can download our report here.
Keep Your Options Open and Don’t Be Afraid to Change Strategies
A correction is also an opportunity to revisit and rebalance your portfolio. Ask yourself:
Has your risk tolerance changed?
Are your investments underperforming/outperforming?
Have your financial needs or circumstances changed?
Minor adjustments are always welcome as long as you keep track of the market conditions and you place your emotions at bay. While it’s tempting to follow what other investors are doing, we all have different risk appetites and financial capacities.
Learn From Your Losses and Avoid Overcorrecting
As brutal as this may sound, you must embrace whatever comes out of the correction. If you lose, so be it, and never attempt to time the market.
While we want the market to rise in a straight line, it doesn’t happen in the real world. Instead of regretting your decisions, use them to your advantage. Research what can happen in the next 5 – 10 years, possibly use technology to automate your investment processes, or seek help from a financial planner. After all, the astute and proactive always wins.