What Does a Market Correction Mean, and Why Is It So Important You Know?
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In recent times, you may have heard finance experts and economists comment on market corrections in Australian share and real estate markets.
However, what does this really mean? Is it cause for panic? And what can you do in the event of a market correction?
In this article, we will demystify these questions, and helping you to determine what action, if any, you need to take.
What Is a Market Correction?
When it comes to assets such as shares, real estate and commodities, prices tend to fluctuate on a regular basis due to a variety of factors, not least of which is supply and demand. When those prices begin to decline, this will be referred to as either a dip, correction, crash or a bear market depending on the size of the price drop and the speed with which it occurs.
Market Correction: Market Correction is considered to be a price fall of 10% or more from its peak. It is important to note that a market correction is different to the share price of a particular company dropping more than 10%. Individual shares will fluctuate on a regular basis, however, if the market as a whole drops, this is what is referred to as a correction. Market corrections typically tend to only last a few months before starting to recover.
Market Dip: Price falls of less than 10% are often referred to as dips or pull backs.
Market Crash: While market corrections tend to be a steady decline over a period of months, a market crash is a sudden drop in price that takes place in a short space of time, such as a day or a week.
Bear Market: Bear markets signal a market decline in prices of 20% or more over a prolonged period of time. They can last months or even years.
What to Do If You Are an Investor
As a new investor, market declines can be nerve-wracking. The most important thing to remember is that unless you sell that particular asset, any decline in value is only a theoretical or paper loss. You haven’t actually lost any money at this stage unless of course you sell that asset and lock in that price. Here are some factors to consider to help you decide if now is the time to sell or hold on:
What Is Your Investment Strategy?
Think back to when you made your investment. What was your investment timeframe? Does a price dip offer an opportunity to buy quality shares at a discount? Are you still receiving income from your investments (dividends from shares or rental income from property)? Are there opportunities for you to diversify your investments in order to reduce your risk?
Can You Afford to Wait It Out?
If prices continue to decline and take a few months or years to recover, how will you be impacted financially during that time? If you have a financial back up plan in place (for example, emergency savings, insurances, family support, other investments) you may find that your lifestyle and goals won’t actually be impacted and you can afford to ride out the storm.
Do You Want to Wait It Out?
In addition to the financial impact of market declines it is important to consider the emotional impact as well. If you find your anxiety levels increasing and you are losing sleep regardless, it is time to consider strategies to support you. Getting professional financial advice can help to put your mind at ease as well as allow you to explore strategies to reduce your risk. If you still wish to pull out of your investment, knowing that you have explored your options before pulling the pin will help you to sleep better at night.
What to Do If You Are a Home-Owner
Purchasing a home to live in is very different to buying an investment. There is so much more to choosing the right property than just price and timing. We buy a home based on emotions and lifestyle factors such as whether we like the suburb, is it near a good school and do we like the floor plan. We buy a home because we are ready to settle down or want the security of a permanent address. So rather than trying to time the market or live in regret that you may have overpaid for a property, focus your attention on the reasons behind the purchase and taking action to ensure that a market correction won’t impact you financially.
Increasing Your Repayments
If prices drop by 10-20%, this only becomes an issue if you wish to sell the property or refinance. In this case you may find that if you sell you still owe the bank money. If you wish to refinance, you may find that the bank doesn’t value the property as high as they did when you purchased it. This would mean that you are locked into paying your existing (likely higher) interest rate or that you have to pay Lenders Mortgage Insurance to refinance. The most effective way to reduce the likelihood of this happing is to increase your equity by making extra repayments on your home loan. This way, no matter what the markets do you will have a financial buffer that allows you to keep your options open.
Give some thought to the types of events that could force you into selling before you are ready and do what you can to prepare for these. Some common examples can be relationship breakdown, job loss or health problems. Building up your emergency savings and having adequate income protection and health insurance can mean that, should these events take place, you are able to continue making your mortgage repayments while you get back on your feet and can avoid defaulting on your mortgage or being forced to sell.
It is important to keep in mind that share or property price movements can be impacted by a variety of factors, and only time will conclusively tell you whether a market decline is a correction or something more significant. The good news is that historically markets have consistently recovered after a decline, it just may take some time. The key to surviving the rollercoaster is to focus your attention away from predictions and forces outside of your control and concentrate instead on those things that you can do something about.
Natasha Janssens is a Certified Money Coach (CMC)® and founder of Women with Cents. She is an award winning financial educator with a passion for supporting women to transform their relationship with money. If you don’t know what you don’t know when it comes to money and financial matters, her book Wonder Woman’s Guide to Money is for you. For more of Natasha’s tips follow her on Instagram and take the Money Type Quiz.