It finally happened>. Market watchers have been talking about the possibility of a correction for months, but this week the Dow Jones Industrial Average, S&P 500 and Nasdaq each fell more than 10% below their most recent highs, meeting the traditional definition of a correction.
Thursday s session marked the final blow. A 376-point slide left the Dow down 3.6% on the day, while the S&P 500 ended down 3.9% and the Nasdaq fell 4.1% -- losses that left the indexes officially in correction territory. Stocks recovered some ground Friday, but for investors, the question of how to respond to the volatility over the past week remains salient.
After the flash crash on May 6, some investors began pulling money out of the stock market. Long-term mutual funds saw net outflows in the week of May 12, with stock funds seeing the steepest outflows, according to the Investment Company Institute. The May 12 week broke a 60-week streak of net inflows.
However, those steady inflows before the crash didn t necessarily signal widespread optimism about stocks. Throughout the bull market that began in March, bond funds saw steady inflows, while equity funds wavered between net inflows and outflows.
Flow of funds data show you what the crowd is doing, says Roger Streit, a fee-only certified financial planner and the president of Key Financial Solutions in Roseland, N.J. Over the past year, the crowd has been missing huge stock market gains by reacting emotionally to the news of the day, Streit says.
Corrections, and even steeper drops, happen regularly. The problem with trying to time the market or guess where it s going next is that you have to be right twice, says Sandip Bhagat, the head of equities at Vanguard. You d have to get out at the right time, and then get back in at the right time, too, Bhagat says. Especially after such a strong rally, there are fundamental issues that equities have to wake up to, Bhagat says. The market is not overreacting, he says, but long-term investors have to remember that stocks are volatile, and stick to their plans.
Bhagat says Vanguard has not seen unusual cash-flow activity in its equity funds over the past week. Representatives of Fidelity Investments and T. Rowe Price also said they saw no signs of panic: A spokeswoman for Fidelity said call volume was normal, and a spokesman for T. Rowe Price said flows to stock funds were positive for the month.
The past two and a half years may have taught some investors a lesson about patience, says Lea Ann Knight, a fee-only certified financial planner and the principal of Garrison/Knight Financial Planning in Bedford, Mass. Far from getting panicked calls from clients looking to pull money out of the market, Knight says her clients saw this correction as a buying opportunity.
So what should investors be doing now? Sticking to their long-term plan, investment professionals say. Investors should resist the temptation to take on more risk to make up for past losses or to shift into cash to hide from volatility, says Kevin Mahn, chief investment officer at Hennion & Walsh. Generally, in a volatile market, value stocks will do better than growth stocks, but investors shouldn t jump to shift money around with every move of the market, Mahn says.
If stocks fall sharply enough, investors can consider rebalancing a portfolio that may now be underweight equities by, for example, selling some bonds and buying some stocks to get back to their target allocation, Streit says. Rebalancing actually forces you to buy low and sell high, he says.