Five ways to prepare for a market correction

12 July 2017

No-one can predict when a market correction will occur, but that doesn’t mean investors can’t be prepared. We offer tips to help, including the importance of understanding that corrections are a normal part of the investing journey.

The value of investments can fall as well as rise. You may get back less than you invest. Tax rules can change and their effects on you will depend on your individual circumstances.

What you’ll learn:

  • How investing regularly can help smooth out market volatility.
  • Why it’s important to keep your emotions in check.
  • How diversifying your investments can help.

Over the past few months, there has been plenty of speculation about when the next market correction is likely to occur, as the FTSE 100 index of Britain’s biggest companies has climbed to record highs in 2017,1 despite fears that political uncertainty both in the UK and overseas would lead to market turmoil.

However, past performance should never be seen as a guide to the future, and there are no guarantees that the index will continue to perform strongly. No-one can say exactly when there will be a correction, but it’s important for investors to prepare their portfolios for any potential stock market storms. It’s also important to remember investments can fall as well as rise, so whatever steps you take to protect yourself from market volatility, you could still get back less than you put in.

Here, we consider five strategies to help safeguard your portfolio.

Focus on quality companies

Investors may want to maintain a focus on quality blue chip companies with strong balance sheets to help them weather any downturn. In the past these companies have often been able to use cash reserves to shore up balance sheets in the event of market corrections, enabling them to pay consistent and reliable dividends to investors, providing steady returns. Always remember though that dividends are not guaranteed. If a company gets into financial trouble, it can reduce its pay-out, or even cut it altogether.

Other characteristics to watch for include relatively predictable earnings that haven't tended to suffer too much during periods of market volatility, and the ability to achieve high returns on investment without having to rely on excessive borrowing.

Investing in individual shares is a risky approach, however, so one option may be to consider a global equity fund that can pick the ‘slow and steady’ companies from around the world that the fund manager believes to be the very best, rather than restricting yourself solely to stocks that trade in the UK. Funds in this sector include the Fidelity Global Focus fund and the Fundsmith Equity fund. However, it’s important to consider that the value of international investments may be affected by changes in foreign currency exchange rates.

Please remember that our mentioning these funds does not constitute a recommendation. If you are unsure where to invest, seek professional financial advice.

Stay invested for the long-term

As the old investment adage goes: “Time in the market is more important than timing the market.” It is impossible for anyone to know exactly when share prices might rise or fall, so investors should remain focused on their long-term objectives, rather than trying to guess when a correction will occur.

Adopting a ‘buy-and-hold’ strategy means that you stay invested throughout market cycles, avoiding the risk of missing any of the best days because you’ve sold at the wrong time.

Of course, there are no guarantees and you could still lose money in the end.

Learn more about buy and hold investing

Invest regularly

Drip feeding your money slowly into the stock market means you avoid the risk of investing a big lump sum just before a market correction.

It also means you invest across a range of prices, so if there is a correction, your money will buy you more shares and fewer when it recovers. This means you effectively pay the average price over a fixed period, which can help smooth out market volatility.

Again, there are no guarantees that investing regularly will leave you better off. You could face the reverse scenario and end up with a loss. For example, if the price of a particular share was volatile and prone to rising and falling sharply, you may end up buying when it’s risen, which would ultimately buy you less shares per pound you invest, as you might be buying them at the higher price rather than the lower price. Also, if you were to split a lump sum into set monthly investments rather than making one, bigger investment up front, you may end up paying more in transaction fees.

Find out more about the benefits of making regular investments

Keep your emotions out of investing

Whatever you do, don’t let your emotions dictate your investment decisions. It’s important not to be scared out of shares by a falling market, so always think about the reasons why you picked your investments in the first place, and refer back to this when you are feeling spooked.

Considering in advance how you may react to a market correction could help prevent you from making any expensive mistakes, for example: selling shares immediately and potentially at a loss, instead of holding on to your investments and waiting for a potential upturn in the market. Although, there are no firm guarantees that falling markets will ever recover their lost ground.

Learn more about the impact of your emotions on your investments

Spread your investments

Investing in a range of assets across different sectors and geographical regions can help minimise losses during periods of volatility, albeit that it will tend to limit gains too.

All asset classes offer the potential for returns, but may perform differently during the same market forces. Ensuring your holdings are properly diversified means that when markets are turbulent, parts of your portfolio will hopefully rise to offset falls in other areas but conversely gains in one investment may be offset by losses in another .

For example, gilts and bonds remain a good diversifier in a balanced investment portfolio, as their prices tend to be affected by different market conditions than share prices.

To get an idea of how risky a particular bond is you should look at its credit rating, which is an assessment of the risk of a company or government not paying back its debt, carried out by a specialist agency. Ratings usually range from AAA, which is the highest rating, to C or D, which are the lowest. Bonds with higher credit ratings are judged by the agency to carry less risk, but offer lower rates of interest.

There are a number of ways to invest in bonds, from investing in them directly, to investing in a fund focused on spreading its assets across a range of different bonds. However, like all investments, bonds come with risk and you could lose money. If you’re unsure, seek professional financial advice.

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