How many times have you read, “A pullback in stock prices is healthy for the financial markets.”
When we see that expression, we ask, “If it’s so darn healthy for investors, why does it make so many people feel upset?”
Over the years, we have found that one reason investors can get unsettled when stock prices trend lower is because they don’t know what to expect regarding the financial markets. They are not familiar with the normal cycles that stock prices tend to move through during the year. They see annual market performance figures, but no one has explained the ebbs and flows that occur over the course of 12 months.
In the accompanying table, you can see that 5% dips in stock prices have occurred 327 times since 1928. Put another way, about every calendar quarter you should expect stock prices to retreat roughly 5%. Drops of 10% or more happen about once a year and bear markets less frequently.1
“Wealth gained hastily will dwindle, but whoever gathers little by little will increase it.” Proverbs 13:11
Part of understanding market cycles is understanding the terms used to describe what’s happening in this regard. Some inexperienced investors use these terms interchangeably, but that’s not the case. To professionals, they all describe a different market cycle, and each has a different meaning.
Pullbacks: Think of a pullback as a reset in stock prices. Pullbacks can be as slight as 5% or as deep as 10%. As you can see from the chart, 5% pullbacks should be expected about once every three or four months.2
Corrections: The next level is considered a correction, which is when stock prices retreat between 10% and 20% after reaching a peak. You should anticipate a correction in stock prices about once a year.2
Bear Markets: When stock prices decline 20% or more from a recent peak they have entered a bear market. Since 1928, a bear market has occurred once about every 3.5 years. The term “bear market” is often used in contrast with the term “bull market,” which refers to a sustained increase in prices.2
Warren Buffett once said, “The stock market is designed to transfer money from the active to the patient.”
Patient investors understand that the stock market can be volatile at times. They also tend not to overreact and, instead, remain focused on their investing goals. Active investors, on the other hand, missed the memo entitled, “It’s all about time in the market not timing the stock market.” They tend to want to move in and out of the stock market, which can be challenging for even the most seasoned professionals.
- CarsonGroup.com, April 16, 2024
- Schwab.com, February 22, 2022
