As markets seesaw, thinking calmly is important to my long-term returns as an investor. Here are three ways I could handle a market correction. I like two of them and will avoid one. Let me explain why.
One way of handling a market correction is simply to sit back and do nothing, for months or even years in some cases.
That may seem at odds with the always-on culture and need for constant action that have become more common in the digital age. But some leading investors reckon that the key to long-term success is not frequent activity, but making a small number of high-quality investments. Let’s say I own Unilever or Tesco, for example. Their share prices could well fall along with other shares in a market correction.
But if the underlying investment case that attracted me to the shares before a market correction has not changed, then my valuation of the businesses will probably not have changed much either. Falling share prices may shake my confidence in the shares, but if I felt the investment case was solid when I bought the shares and the facts have not changed much, as a long-term investor I could do nothing and wait in the hope that the share price will recover in future.
Use a market correction as a buying opportunity
In fact, if a share I own has crashed in price, it could be a buying opportunity for my portfolio. Basically I can buy what I bought before, on sale. Sometimes that can be hard psychologically, as it could make me feel I overpaid before. But if I am confident in the investment case and the price has fallen, logically I think it makes sense to consider buying more of the shares for my portfolio. One thing to watch out for with this approach, however, is the importance of maintaining a diversified portfolio as a way of reducing risk. Buying more shares in companies I already own could make my portfolio less diversified.
I would also apply this approach to companies I like but have seen as overvalued. For example, stocks like Howden Joinery, Victrex and Judges Scientific have all caught my eye. But I have seen their share prices as too high to add them to my portfolio. If a market correction leads to their prices tumbling, that could present me with a buying opportunity.
Jump in and out
A lot of people see a market correction as a chance to jump in and out of shares, hoping to make fat profits from wild price swings in a short period of time.
The downside I see to that approach is that it is not investing, but simply speculating. Instead of buying shares in companies based on the attractiveness of their long-term business prospects, it involves making choices based on price. In a market correction, there can be far more volatility then normal on stock markets.
As an investor with a long-term horizon, I do not adopt this approach in a market correction. Instead, I focus on the same investment style I use when markets are calm: identifying great businesses at an attractive price I can hold in my portfolio for the long term.
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Christopher Ruane owns shares in Unilever. The Motley Fool UK has recommended Howden Joinery Group, Judges Scientific, Tesco, Unilever, and Victrex. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.