What's a market correction? How market changes may impact your investments

Market corrections—declines between 10% and 20% that follow recent highs—are a normal part of stock market cycles. These events often reflect shifts in investor behavior due to new national policies or global developments. Understanding the causes behind market corrections can help investors stay grounded.

It can be emotional to see your investments drastically rise or drop. But understanding what causes market changes and how a stock market correction differs from other conditions can help you make informed decisions. When you weigh your long-term goals against historical market performance, you may see the value in staying the course rather than reacting to or chasing trends.

For your best financial strategy during market changes, chart a steady path that aligns with your risk tolerance, financial goals and investment opportunities. Here's what to know and how to be prepared for market corrections.

A market correction is a decrease in the value of certain securities or an entire financial market by at least 10% shortly after reaching a peak high. If the decline is more than 20%, it's considered a bear market. Understanding the difference between a market correction and a bear market is key to managing expectations and avoiding panic-driven decisions.

This significant and sudden drop can occur if investors lose confidence in anticipated economic growth.

A stock or other asset's value is always dependent on how many people value it and how much they'll pay for it. Prices for different assets fluctuate as a result, and market corrections can happen for a variety of reasons, including:

• Economic data shifts. Changes can happen after financial reports show a new trend, such as widespread falling profits.
• Global events. Political unrest, a pandemic or supply chain problems can impact prices and value.
• Investor sentiment. Whether investors think a recession is likely in the coming months can influence the market.
• Government policy changes. Reactive fluctuations can follow tightened financial regulations or interest rate changes.

These events may drive investors to want to sell fast before an anticipated fall. By selling all at once, they can prompt the fall of their own investments.

On average, a market correction only lasts a few months before the market recovers. Selling long-term assets in a panic when a correction may be short-lived reflects a basic misunderstanding of how the stock market works. It's important to take a longer-term view, realizing that the market ebbs and flows.

For the most part, market corrections are relatively brief—about four months on average based on historical data. They tend to happen every two years or so, though they don't occur on a predictable schedule and usually don't turn into bear markets.

Reuters and Yardeni Research report 56 U.S. market corrections since 1929. Only 22 of them persisted in falling 20% or more, which is when a market correction turns into a bear market. While market corrections can raise concerns that a bear market or recession could be next, the reality is that market corrections don't always predict a further fall.

Adapting your financial plan

It's easy to let temporary challenges change your well-researched approach to investing. Learn more about risks that can derail your financial plan.

Knowing what different terms mean can help you stay calm as you process unfolding economic news. For example, a market correction doesn't always signal a long-term economic problem. Each of these financial terms is defined by specific factors:

• Market crash. This is a sharp and sudden drop in financial markets, sometimes happening over a couple of days. It's often the result of panic selling rather than a measured analysis of changing economic expectations.
• Market volatility. When the market goes up and down more sharply than usual, it's an indication of a volatile financial market. Volatility makes it hard for investors to commit to big decisions because they don't know if their assets will be overvalued or undervalued on a given day.
• Recession. Recessions are an economic indicator, not a market indicator, and are typically declared after two consecutive quarters of declining gross domestic product (GDP). During recessions, the economy typically suffers, and unemployment often rises. Sometimes low inflation accompanies a recession, though it's possible to also encounter a sluggish economy with high inflation, a rare but frustrating condition known as stagflation.

Because market corrections are a normal and recurring function of financial markets, you can confidently prepare for them with the right long-term strategy. Here are several tips to get started:

If your investments are all in a single asset class, they're more vulnerable to big market swings. But a diversified portfolio, where you invest in a variety of assets, is more likely to withstand market volatility. Achieving diversification is easier than ever since many assets, like index funds and mutual funds, include some diversification in a single financial product. By diversifying, you can spread out the risk that comes with a market correction.

Ultimately, your risk level is what determines the intensity of your highs and lows when the market shifts. With a low risk tolerance, your gains during a booming market typically will be lower, but you're less likely to see big losses as well. Risky investments (or a high risk tolerance), however, can mean greater potential for wins and losses and the accompanying higher volatility.

Regardless of your personal risk tolerance, understanding what you stand to gain and lose amid market volatility can help you be more prepared for whatever comes.

You don't need to have a high net worth or income to get advice from financial professionals. Everyone from first-time to seasoned investors will have questions about what to do during a market correction, including strategies for weathering them based on unique personal situations and goals.

For example, a financial advisor can help you decide if recent changes in the financial markets have misaligned your portfolio. They also can help you strategically sell and buy assets—or rebalance your portfolio—to get back to your preferred asset diversification and risk tolerance.

The most important thing to do during a stock market correction is to stay calm and avoid making emotional decisions. Regardless of what the market is doing, it's important to keep your risk tolerance, investment time frames and long-term financial goals top of mind.

Here are a few strategies to avoid common investing mistakes.

• Avoid making emotional decisions. The news and other media sources are designed to attract your attention. Even if you're worried, it's usually best to stay focused on your long-term plan for achieving your financial goals.
• Keep saving and investing. Changing your savings and investing habits during a correction can undo years of hard work. Of course, if your financial needs change, you may choose to alter your budget. But it's typically best to stay the course with your savings and investments if your only worry is market performance. For example, continuing to invest in employer-sponsored retirement plans regardless of market conditions can mean continuing to reap a valuable employer match while the market goes up and down over the years.
• Understand potential opportunities. If you've been holding back and have some uninvested savings, "buying the dip" may be a strategy you want to consider. However, talk with your financial advisor before going forward with any strategy that involves timing the market during volatility as this can be a difficult thing to do successfully.
• Consider dollar-cost averaging. Investing the same amount of money regularly—a strategy known as dollar-cost averaging—rather than trying to time the market, is almost always a better strategy because it involves less risk. Historically, the market has gone up in the long term, making dollar-cost averaging a wise way to invest through varied short-term conditions.
• Know where to invest. A big advantage of a diversified portfolio is that your risk is spread out. Market conditions will have varying impacts on the value of different asset classes when investing during a downturn. As a result, a diversified portfolio often cushions the impact of a downturn, even if you still see some short-term losses on paper.

Ultimately, market swings are part of a long-term savings strategy and are unlikely to completely derail your goals. Because market corrections have happened a lot in the past few decades, you have strong strategy options for investing in volatile markets.

Panicking, making fear-based choices or drastically changing your strategy every time the market falls is unlikely to help your long-term savings and investment plans. Instead, knowing your risk tolerance, diversifying your portfolio and saving consistently are valuable strategies. Don't let a temporary market correction undo years of hard work. With a resilient, long-term investing strategy, you can navigate volatility and stay focused on your financial goals. Connect with a local Thrivent financial advisor, who can give you the confidence to stay the course with a well-considered strategy that's personalized for your goals.