Investment Fundamentals: Corrections, Bears and Crashes

March 4, 2019

The most important thing an investor can do is avoid making emotionally-driven investment decisions when one of these declines occurs.

Corrections, bear markets and crashes are terms used to describe stock-price declines of varying severity.

Stock-market declines can cause investors to panic and start wondering if they should make changes to their portfolios. No one likes seeing losses. But it’s important to consider the severity of each market downturn — whether it’s a correction, bear or crash — before deciding to alter a long-term investment strategy.

Market corrections (least severe)

  • Defined as a decline of 10% or more from the most recent high
  • Occur about once per year in the U.S. and last about two to three months
  • Serve to keep stocks from becoming overpriced or inflated — correcting market exuberance that may otherwise result in stock prices rising faster than is justified by underlying company earnings

Bear Markets (second most severe)

  • Defined as a sustained decline (at least two months) of 20% or more from the most recent high
  • Occur about once every three years in the U.S.
  • The bear market sparked by the global financial crisis in 2007 disappeared two years later

Crashes (most severe)

  • Defined as a sudden decline (such as within a single day or week) of 50% or more from the most recent high
  • Occur far less frequently than corrections or bear markets
  • Typically followed by recession (defined as two or more consecutive quarters of economic output falling by at least 10%) or depression (loosely defined as an even steeper, more prolonged decline in economic output)

Corrections, Bear Markets and Crashes of the S&P 500 Index

Diversification may help mitigate risk and provide solace when the market inevitably heads south.

What's an investor to do when a market decline occurs?

Whether the market corrects, becomes a bear or suddenly crashes, we believe the most important thing an investor can do is avoid making investment decisions based on emotions.

This is particularly true when it comes to stock-market corrections. Despite the regularity of these less severe slumps, the S&P 500 Index (which is widely regarded as the best gauge of large-capitalization U.S. stocks) has gained an average of 10% over the last 50 years (according to Bloomberg, as of 12/31/2017) — signaling, in our view, chances of recovering correction-related investment losses relatively quickly. We therefore think it’s best for long-term investors to wait when faced with these less significant downturns.

A similar logic applies to bears and crashes. The odds of realizing a loss actually increase when we purge stock investments in response to major stock-market downturns. Doing so also means potentially missing out on gains during an eventual recovery. We think a better approach is thinking of these low periods as opportunities to buy stock at a discount.

It’s difficult to predict a market downturn, and it’s even harder to forecast the severity or duration of a given slump. What investors can do is assess their portfolios in context of their long-term investment goals, being sure to diversify across a variety of asset classes, industries and countries. This can help to mitigate risk and provide some solace when things head south — as history shows they inevitably will do.

Legal Note

Important Information

This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice and is intended for educational purposes only.

Index returns are for illustrative purposes only and do not represent actual fund performance. Index returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

There are risks involved with investing, including loss of principal. Diversification may not protect against market risk. Information provided by SEI Investments Management Corporation, a wholly owned subsidiary of SEI Investments Company. Neither SEI nor its subsidiaries is affiliated with your financial advisor.