3 Strategies to Survive a Stock Market Correction
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"Ugly" is a perfect four-letter word to describe what the U.S. stock market has done over the last couple of trading sessions, although it may not be the four-letter word of choice for some investors.
Since last Monday the Dow Jones Industrial Average has shed nearly 10%, the S&P 500 is off about 10%, and the Nasdaq Composite, which is heavily weighted toward higher-growth technology and biotechnology stocks, is down 11%. All three indexes are now sitting well into stock market correction territory, with the Dow, S&P 500, and Nasdaq off 13.5%, 11.3%, and 13.5%, respectively, from their all-time highs.
By definition, a stock market correction is when a market index falls 10% (or more) from its recent highs. Although stock market corrections are quite common -- they happen about once every year -- we haven't seen once since Oct. 2011, and clearly some traders are unnerved by the speed at which the selling has intensified in just a matter of days.
However, a stock market correction doesn't have to be viewed as a doomsday event for investors. In fact, if you approach investing with a long-term mind set and stick to your game plan, then there are a number of pathways you can take to survive a stock market correction. Here are three such strategies you can consider employing.
1. Purchase high-quality dividend stocksIf you want an easy way to avoid the panic that may be associated with a stock market correction, then consider buying high-quality dividend stocks.
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Dividend stocks serve a number of purposes for investors, and those benefits can really shine when the stock market is correcting. To begin with, a dividend payment can help offset the paper losses you sustain when the stock market is retreating. It's true that a dividend payment is unlikely to counteract the entire unrealized losses you've potentially sustained in the past couple of days, but over the long-term your dividend stock could double or triple your investment by itself all from dividend disbursements.
Secondly, stocks that pay a dividend on a regular basis are beacons for investors, demonstrating that a company is confident enough in its long-term outlook and business model to share its profits with investors. If a company can regularly increase its payout to shareholders, then it implies that it has a relatively healthy business model with long-term staying power.
Lastly, dividend payouts offer you the ability to compound your future dividend gains by reinvesting those dividends into more shares of stock. Over time, the combination of owning more shares of a dividend-paying stock and receiving higher payouts from a larger holding of that stock can help offset unrealized losses from a stock market correction.
Looking for a great place to start? Why not consider healthcare conglomerate Johnson & Johnson! Johnson & Johnson has increased its payout in each of the past 53 years, it's working on a 31-year streak of adjusted earnings-per-share growth, and it's one of just three publicly traded companies sporting a "AAA" debt rating from Standard & Poor's. It's also paying out a market-topping 3.2% yield.
2. Focus on basic-needs stocks or brand-name goods and servicesAnother strategy that smart investors can use during a stock market correction is to focus on businesses that sell a basic-need good or service. And yes, many companies that provide the bare necessities of life are also high-quality dividend stocks, so it's really the best of both worlds.
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Why basic-needs companies? Because there are certain goods and services that won't be materially affected by a stock market decline -- a decline that, on average, tends to last less than two quarters.
Take Procter & Gamble as a good example. During the Great Recession, many cyclical consumer businesses were hit hard -- but not Procter & Gamble. Although P&G did observe some instances of trade-down in the grocery aisle -- whereby consumers would opt for generic-brand products, rather than P&G's premium consumer products -- these were generally minimal. For the most part, consumers continued to buy P&G's detergent, toothpaste, paper towels, and other essential everyday goods, regardless of the stock market's fluctuations.
Procter & Gamble also understands that because many of its goods fit the description of a basic need, it has little incentive to discount, which further bolsters its margins and could shield the stock from the excessive selling and emotional trading often witnessed during a stock market correction.
3. Do nothingFinally, you can simply choose to do nothing other than get a good night's rest.
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The presumption here is that you've already done your homework and picked out high-quality stocks for your portfolio. All that might be needed during a stock market correction is for you to revisit your investment thesis with each stock. In other words, if the reasons you bought a stock are still just as valid today as they were the day you bought it, then there's no need for any action, regardless of how far it may have fallen from its highs. If, however, the underlying business model has changed, or your investment thesis no longer holds true for whatever other reason, then it may be time to part ways with your stock.
What you don't want to do is unload your investments simply because of fear or other emotions. This happened to some baby boomers during the Great Recession, and they subsequently missed the meteoric rally in stocks of the last six years.
Keep your eyes on the long-term prize, and this stock market correction, like previous stock market corrections, can be but a blip in your rearview mirror.
The article 3 Strategies to Survive a Stock Market Correction originally appeared on Fool.com.
Sean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, track every pick he makes under the screen nameTrackUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.The Motley Fool recommends Johnson & Johnson and Procter & Gamble. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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