10% Correction

Market prices move quick.  I wrote about this last year in regards to how quick markets went down and recovered from the Brexit selloff and during the night of the US election.

The global markets (represented by iShares MSCI All Country World Index ETF – “ACWI”) made a closing high on 1/26/2018, and then over the next nine trading days, the ACWI went from making all-time highs to being down 10%.  Then, the ACWI went up 5% in the next five days.

ACWI -YTD 18

To me, that’s quick.  As someone who is regularly investing excess cash flow into stocks, I welcome dips in the market because I hate putting money to work at all-time highs.  On the flipside, I don’t want to see a significant drawdown because I like it when my portfolio compounds and losing money hurts compounding.

The table below shows the % off the most recent closing high for iShares MSCI All Country World Index ETF.   The 0.00% means the portfolio was hitting new highs and a negative number indicates how far the fund is away from its previous top.  January was a spectacular month with a lot of new highs.  February looks much different.  As you can see, the drawdown began on 1/29 and hit the lowest point on Feb 8.  As of today, the drawdown is 5% away from making a new high.  For someone putting money in the market, it would have been nice to have stayed down at 10% for a little longer.

 

ACWI % off the high

With that said, who had the opportunity to add a substantial amount of money to their investments when the market was down 10%?  Most people get paid every two weeks and let’s assume you add to your 401k or investment account every time you get paid.  You may have bought on Jan 2, on Jan 15th,  on Feb 1st, and then bought yesterday (Feb 15th).   This type strategy is called dollar cost averaging (DCA).  In its simplest form, DCA is where you add to your investment at regular intervals with the same dollar amount.  Because prices are continually changing, you will be “averaging” your cost basis in the stock or fund you are investing in.  The prices moved so quick that we bought more at the tops than at the bottom in February based on the assumptions above.

The table below shows how many shares you would have purchased with the $1,000 DCA strategy from above.  The example assumes you purchased shares at the closing price.  So, you invested $1,000 at different purchase prices (or share prices).  The average price you paid is $74.42 (=$4,000 divided by 53.7).  The lowest closing price in February was $69.83 which was on the 8th.  None of our purchases hit the lowest closing price.

table

This is a brief period of time to show, however, I thought it would be worth noting to help you understand how this strategy works.  Also, you can not control when these types of events happen.  By the way, this was the first 10% correction since February 2016.

Use your future cash flows to your advantage.  If we get another dip, you can take advantage of the dip by transferring money from a bond fund or another fund that might not have gone down in value and buy more of the fund that went down 10%.  The remaining purchases throughout the year can go back into the bond fund

Imagine holding a large amount of cash and waiting because you were waiting for a 10% correction.  If you were expecting to invest after the correction and “catch” the bottom, you would have had to deploy most of the money on Friday, February 8.    Look at the darkest red on the chart.  The ACWI reached a 10% correction on that day, but it did not stay there for long.

Preparing your portfolio in the event of the selloff is one thing (rebalancing, short-term needs in cash, safe investments in the portfolio).  Preparing to put your money to work when the markets are tanking is entirely different.  Are you adding money when the price hits a 10% correction?  How will that money be allocated once those buy signals/targets are hit? Is the cash that you want to invest even in an account that can buy and sell stock or bonds?

Whether it is because of market structure or advancement in technology (computers, algorithms, etc.), it seems market prices are moving extremely quickly. If you were waiting for a pullback to put money to work, it is highly unlikely that you will catch the bottom.  You don’t have the trading capabilities to compete with the high-frequency traders or hedge funds that are buying and selling in nanoseconds.  Most investors do not have a trading edge or an informational edge (private information); therefore, the only advantage you really have over other players in the game is in thinking long-term and having a plan when times are good and when times are bad.   Most people are aware that markets are volatile and that 10% corrections occur.  But the quickness of these events is breathtaking.  If you are sitting on cash and waiting for a market blow up before you put money to work, how do you know that you will actually take advantage (buying or selling) when it does.