What Does "Correction" Mean?

For just about everything in the financial world, there’s a nickname, abbreviation, or acronym. You’ve probably heard about a bull market (20% or more up from the low) and a bear market (20% or more down from the high), but do you know what a correction is?

A correction is a downturn of 10%-20% from the most recent high. While there is no theoretical limit to the length of time a correction can last, according to research from Goldman Sachs, the average correction for the S&P 500 lasts only four months with values falling around 13% before prices begin to recover.

Corrections are a normal, near-annual occurrence in the stock market. With just five corrections in the last decade, the relative lack of downward volatility over the last 10-years has been the anomaly. Since 1950, about one out of four corrections eventually devolves into a bear market – most recently in 2022.

Corrections can occur because of a variety of factors. Increased interest rates and rising unemployment are usually cited as the most common reasons, but those often result from other economic variables. Trying to pinpoint one specific culprit is usually an inexact science.

Corrections are not fun. It’s painful to watch your account value seemingly drop every day. Nobody likes to lose money – which is exactly how a correction feels.

So, what should you do in the midst of a correction? Both history and academic research are clear. If you’re fully invested, you should hold (and not sell) as long as you own quality investments.  If you have investible cash available, now is probably a good time to put it to work. The market could continue to fall from here – there’s no way to know for sure – but history says in three to five years, you’ll be much better off than if you buried the cash in your backyard.

Photo by Luke Southern on Unsplash