The year 2013 has been a great year for stocks. Year to date, the S&P 500 Index is up 25%, other US stocks 31% and international stocks (large cap, developed) 19%. The stock allocation of an investment portfolio should look great.

 

With key stock market indicators reaching new highs almost every week, some investors and commentators are starting to ask if a stock market correction is coming.

Portfolio managers need to be wary.

 

I don’t normally make forecasts, but in this case I think I can say with some certainty that, yes, a correction is coming. The only questions are when and by how much.

 

I can say this because stock market corrections are always coming. There has never been a time when a market correction wasn’t in our future. An Investment advisor should recognize this; the average client does not.

 

On average, the stock market – as measured by the S&P 500 Index – has declined

Sounds pretty bad, doesn’t it? And, if a decline is coming, why stay invested in the stock market?

 

It is bad only if you look at the declines. Looking at the subsequent recoveries reveals something else. The average recovery increases in proportion to the decline that preceded it.

 

 

The average post-decline increases were usually greater than the decreases so, over long periods, investors who stayed invested and took the losses were compensated by increases in the value of their stock market investments.

 

It is important to note that past performance is no guarantee of future performance. The information is not a complete summary or statement of all available data necessary for making any decisions and does not constitute a recommendation.

 

Stock market volatility (the constant increases and decreases) is not a risk; it is a certainty. There will always be volatility and by large amounts.

 

Investors who buy before a market advance or sell before a decline are called “market-timers.” Those content to stay fully invested are called “buy-and-hold” investors.

 

Buy-and-hold investors usually outperform market-timers. Market-timers don’t know in advance what day the stock market will peak or hit bottom. Those dates are only known afterward. If someone does sell at the peak or buy at the bottom, it is luck – not skill.

 

What usually happens is that market-timers sell before or after the market peaks, missing some part of the gain. They buy back before the market bottoms or after the market begins recovering, incurring some part of the market loss. Or maybe they never reinvest in stocks.

 

Market-timing causes other problems. Being out of the market also means missing dividend payments. At today’s prices, an S&P 500 Index Fund pays dividends equal to 2 percent of its value, a 2 percent “dividend yield.” A market-timer’s investment could be in a money market fund earning less than 1 percent. The buy-and-hold investor continues to benefit from dividends, which don’t decline because of declines in stock prices.

 

Finally, market timers are incurring expenses to buy and sell. In taxable accounts, they pay taxes on their gains. Buy and hold investors don’t incur expenses and don’t pay capital gains taxes until sales are made.

 

This doesn’t mean that stocks are always a good long-term investment or that the current strong rally will continue. It does mean that, if you are going to invest in stocks, buying a well-diversified portfolio and holding for long periods could be a better – and easier – strategy.