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One of my favorite folk tales centers around a landowner who hires a farm laborer. When they first met, the Applicant explained his qualifications saying “I can sleep in a storm”. A week later, a severe storm hit the area and the farmer tried unsuccessfully to wake the farm worker. The next day the farmer found that the shutters had been closed, the tools had been securely stowed, the wheat had been tied and wrapped, the barn had been locked, and the animals were calm with plenty of food. Suddenly the farmer understood the young man’s words: “I can sleep during a storm.”

He had prepared in advance and could sleep peacefully during the storm. Sleeping well is the second goal of investing and becomes easier with the right preparations. (The first goal is not to lose money, and the third goal is to make money.)

By taking the right precautions now, you can sleep soundly when the stock market drops sharply and stays there for a while, which is bound to happen someday.

“The proverbial Wile E. Coyote moment is coming,” said James Athey, chief investment officer at Aberdeen Standard Investments in London, referring to the fast runner who looks down to see he’s hurtled down a cliff, surrendered reckons that he has no more ground under him and collapses.

Warner Bros / Everett Collection

What lies behind the fears of a market correction

Stock market volatility, caused by a range of factors including concerns about inflation, interest rates and supply chain issues, amplifies fears of an upcoming market correction (i.e. i.e. a drop in stock prices of more than 10% but less than 20%) or even a crash (a sudden and abrupt drop).

See: Risk of ‘hard’ correction in market valuations is increasing, Deutsche Bank says – here’s why

Markets (and by extension investors) suffered a heartbreaking day on Wednesday, December 1, when the Dow Jones Industrial Average DJIA,
+ 0.51%
fell 652 points or 1.9%. The S&P 500 SPX,
+ 0.92%
closed 1.2% lower, its worst drop in a day since mid-May. Stocks fell sharply again in mid-December. But the S&P 500’s total return for 2021 was impressive – around 25%.

Preparing for a correction starts with understanding the inevitability of small corrections and the lesser likelihood of a major correction, says Alex Klingelhoeffer, financial advisor at Oklahoma City-based Exencial Wealth Advisors.

A correction is always around the corner, ”he notes. “As a rule of thumb, we do a garden variety correction once every 18 months. »Deeper corrections occur less frequently.

“What keeps people from sleeping at night is the biggest. Major corrections of over 20% have occurred seven times over the past 100 years, ”says Klingelhoeffer. They were in 1929, 1937, 1939, 1946, 1973, 2000 and 2007.

See: This Seasoned Analyst Hears Echoes of Today’s 1929 Stock Market Crash

The best defense for investors

Diversification is the best defense. This means having enough cash and bonds in your portfolio to cover all foreseeable expenses for five years. This means trading the low income generated by those assets for having to sell stocks eroded by a correction.

The current 1.21% interest rate on, say, five-year Treasuries “is a terrible rate,” Klingelhoeffer says, but “if the market corrects itself and you have a 30% cut, your bills are not going to go down “.

See: Your portfolio isn’t as diverse as you might think, unless you use this powerful strategy

Stable sources of income such as wages, pensions, and Social Security can reduce the total amount you might want in cash and cash equivalents as protection against a stock market meltdown.

It also helps to hold stocks in international markets that might not go down as much as the US market during a correction.

The emerging markets of Brazil, Russia, China and India, which have lagged the United States for more than a decade, are not all moving in the same direction at the same time.

Real growth in the global economy comes from these areas and they can provide opportunity and ballast for a US-centric portfolio, especially when US markets are underperforming.

Precious metals such as gold and real estate investments can also be reassuring. “They don’t make any more earth,” Klingelhoeffer adds.

He also prefers to invest money in a basket of basic commodities, including wheat, corn and lumber.

“These are things that we use and need to live,” he says, adding that they have a low correlation with the overall stock market. You can invest in commodities through exchange traded funds or ETFs.

Also see: 10 things to know about diversification

Investors may have some time to implement these strategies (but not unlimited time), as a major correction could occur over six to 12 months, according to Athey.

Al Emid writes about personal finance and business in articles and books. He also produces the financial podcast “Indepth Investing With Gavin Graham”.

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