Squeamish investors might want to look away. But has anyone else noticed how rough the first month of 2014 has been on the stock market?
If the Dow Jones Industrial Average resolved to slim down as part of a New Year’s resolution, it’s doing a fantastic job. For the first month of 2014, the Dow dropped over 6.5%, giving back all of the forward progress the market made since the middle of last October. While it has recovered slightly in the past week, financial experts predict we may be headed into a period of volatility.
The recent volatility in the stock market is probably confusing and a little scary to us casual investors; let’s take a look at this recent downturn in the Dow, what’s causing it and what you could/should do about it.
What’s Behind the Recent Skid?
By all accounts, things look pretty good on paper right now. The economy is improving. The United States didn’t default on its debt obligations. There hasn’t been much drama in Washington about the federal budget or debt ceiling.
So, why has the Dow dropped almost 1,000 points in a little over a month?
Some analysts warn we may be heading into a correction.
What’s a correction? Well, as the saying goes, “What goes up must come down.” You see, 2013 was a great year for investors. The Dow was up almost 25% on the year, a return that’s much higher than the norm.
The rise in the markets is fueled by eager investors looking to get in on the action. This can lead to the over-inflation of stock prices, and the inevitable correction as prices return to their actual value. It’s hard to sustain a period of rapid growth. Eventually, the pace will slow and investors will react unfavorably.
The markets can also become unreasonably spooked by bad news like disappointing economic indicators, trouble in financial markets abroad, or weak corporate earnings data. Under normal circumstances, marginally discouraging news would have a nominal effect on the markets. But during a correction period, the negative effects can be exaggerated.
Remember, stock markets are institutions that were created by people. People can behave irrationally. So, the institutions that they create can behave irrationally as well.
Corrections have followed just about every significant stock market gain of the past half century or so. Selloffs of around 10% or so following a period of rapid growth, like 2013, are normal. Economists maintain that it is a natural part of the stock market cycle.
So What Do You Do When the Stock Market Goes Down?
If we’re in for a market correction, you can expect the stock markets to lose close to 10% or so. We’re not quite there yet, so there may be more bad news on the horizon, even though stocks have rallied in the past few days.
Resist the temptation to pull out and sell your stocks. You might be turning losses on paper into losses in reality. Your investments don’t have actual value until you buy or sell them, so make sure you’re not selling when prices are low.
When the market is down, like during a correction, it can actually be an opportunity to make more money in the long term by investing more. Remember the cliché advice of “buy low, sell high.” Market corrections are a good time to buy low.
As always, please consult with a financial services professional before making investment decisions, to determine if it’s the right decision for you. But remember that the long-term trend for the stock market is always up, so there’s a good chance that any setbacks we’ve experienced are temporary.
Make sure you have your long-term financial goals in mind before you make short-term, reactionary decisions.