How to make the most of a market correction

[SINGAPORE] The Nasdaq Composite Index slipped into correction territory last Thursday (Mar 6), marking a 10 per cent decline from its recent peak. In theory, this is good news for investors. After all, a market correction allows you to buy stocks at a discount.

But in reality, many will shy away, fearful that share prices will continue to fall.

This raises a key question: Why is there a disconnect between what is rational and actual investor behaviour? Here is a hint: when you are under pressure, even the most familiar tasks can suddenly feel monumental.

Take football penalties. When a penalty is awarded during a match, players score approximately 85 per cent of the time. But if the match goes to a penalty shootout and the pressure is heightened, the conversion rate drops to 76 per cent.

Here is the most revealing statistic: If a player must score to prevent his team from losing, the success rate dips dramatically to under 60 per cent. The same phenomenon applies to investing.

When under pressure, simple beats complex

Market declines can exert stress on unprepared investors, causing your head to swirl with emotions and competing thoughts. In my view, the last thing you need in this situation is complex formulas or mathematical equations. You will be better off with simple rules which you can follow and put into action.

But what are the rules to follow? Let me suggest a few.

1. Stay calm: The best strategy in the stock market is to have a calm mind. You can buy a great stock at a favourable price during a market correction. But if you lack the mental fortitude to hold those shares, you may end up selling at the first sign of trouble.

The good news is, a few basic steps before you invest can make a world of difference. For instance, consider setting up an emergency fund. The key here is to park your funds in a place you can access at a moment’s notice. The emergency fund acts as a safe harbour, a source of cash you can access when you need it most.

Alternatively, if the steady flow of income soothes your mind, consider investing in dividend stocks which can provide regular income. Either way, prioritise your mental well-being. It is the key foundation to all the investing decisions you make.

2. Tune out the distractions: If day-to-day stock price movements keep you up at night, consider removing the daily stock price movement column altogether. How much a stock price changes in a day should play no part in how you pick stocks anyway.

Financial headlines can sometimes be a distraction too. Take Meta Platforms. Three years ago in 2022, the Financial Times highlighted the social network’s woes, calling them a perfect storm. In addition, the article went into great detail about the problems Meta was facing, from the rise of TikTok as a competitor, to Apple’s privacy policy which effectively kneecapped its targeted ads, costing Meta US$10 billion in lost revenue.

But here is the thing. Delving into the negatives can often blind you to the positives. While TikTok’s short-form videos were indeed a threat, there are many other formats where Meta dominates in user engagement across WhatsApp, Instagram, Facebook and Messenger.

That is not all. Amid the challenges, Meta had already been working on an Advantage+ Shopping solution for advertisers three years ago. Today, Advantage+ Shopping campaigns have become a key growth driver, exceeding a US$20 billion revenue run rate in its latest quarter.

In the process, the new revenue source has put concerns over Meta’s lost revenue to rest. Clearly, if you had listened to the naysayers, you would have missed out on the positives.

3. The stock price obsession: Another unfortunate trait among investors is their focus on timing their entry into the stock market. This practice is prevalent, especially during market corrections. They hope to catch stock prices as close to the bottom as possible.

But here is the truth: The lowest stock price can only be known in hindsight. Short-term stock price movements are unpredictable. In the near term, be prepared for the possibility that the stock price may fall below your purchase price.

Going back to Meta as an example, if you bought shares three years ago, on Mar 7, 2022, you would have paid roughly US$187 per share. The next eight months saw a dramatic drop, with the price plummeting to nearly US$88 in November 2022.

But here is the kicker. Today Meta’s stock price is trading above US$625; you would have made substantial gains whether you bought in March 2022, November 2022, or any point in between.

Sure, it would be great to get shares at their absolute low. But have you ever seen a sad investor who made more than 230 per cent in returns (excluding dividends) by buying at US$187 per share?

The point is, you do not have to be perfect in your entry price. As long as the business does well, the stock will eventually follow.

4. Discipline in investing: Some investors believe in exercising restraint by avoiding stocks when they are overvalued. I would argue that you also need to do the same when a market correction hits. When stocks go on sale, it is easy to lose your bearings and buy the wrong stocks.

As investors, we should exercise restraint in how quickly we buy, so that our cash does not run out before the big opportunities turn up.

How do we moderate ourselves? Morgan Housel, a best-selling author and partner at the Collaborative Fund, once provided a simple blueprint based on the size of the market decline.

We have adapted his idea in the accompanying graphic, based on putting US$1,000 of cash to work.

More importantly, these percentages are easy to understand and follow. The decline intervals provide you with a yardstick to moderate how you deploy your funds.

Get smart: Buy to own for the long run

Market corrections are filled with noise and distractions. Simple rules can help you cut through the din, and focus on buying the right stocks.

Bear in mind that what a market correction throws out may not always be what you need for your investment portfolio. As always, you should invest in businesses which you want to own for the long term and not necessarily select what is on sale during the downturn. That is the final principle to commit to your memory.

You have to accept that your entry point will be imperfect. But as Meta has shown, being imperfect is perfectly fine.

The writer owns shares of Apple and Meta Platforms. He is co-founder of The Smart Investor, a website that aims to help people invest smartly by providing investor education, stock commentary and market coverage.