There can be a variety of reasons for a stock market downturn, including economic events, wars and other geopolitical events, natural disasters (including pandemics) and changes in laws or policies. Most of these events are rarely predictable.
For much of the time, these dips and increases are typically small and inconsequential. However, larger stock market downturns do happen with considerable regularity, and it’s this constant threat of stock market volatility that can make investing a daunting prospect for many would-be investors.
The good news is that the stock market, on the whole, has always grown in value over the long term. For example, the S&P 500 Index (an index that tracks the performance of around 500 of the largest U.S.-based companies) saw average annual returns of just over 10% between 2003 and 2023. And these returns were in spite of the index dropping in value during six of those years.
Let’s take a look at the different types of stock market downturns, how often they happen, how long they take to fully recover and how you can protect your portfolio against them.
The different types of stock market downturns
Stock market downturns have different names, depending on their severity. A decline that’s less than 10% is often called a dip, a pull-back or a sell-off. A market downturn that sees a drop in value of over 10% and less than 20% is referred to as a correction.
A sudden and drastic downturn across a major cross-section of a stock market is called a crash. A downward trend resulting in a loss in value of 20% or more is called a bear market (as opposed to a bull market, which is an extended period where stock values rise).
How often do stock market downturns happen?
While market dips happen quite often, corrections and crashes are far less common. For the S&P 500 Index, over the last 80 years, there have been 24 corrections, which had average market declines of just over 14%. It usually takes around five months for a correction to reach its lowest point.
Market crashes for the S&P 500, however, are even rarer, having happened only 13 times since 1950. Importantly, the bull markets that follow market crashes are typically very long. Larger crashes, of 30% or more, are extremely rare; there have only been six of them since 1950.
How long does it take for markets to recover from a downturn?
It can take the markets considerably longer to recover from a downturn than the time it takes to reach its lowest point. This is because the markets have to grow by a larger percentage than the amount of the drop.
Let’s use a simplified example to illustrate this point. A market index valued at 100, which saw a downturn of 20% would be reduced in value to 80. To fully recover — by growing in value back to 100 — would require growth of 25%. If the same index saw a drop in value of 50%, it would need growth of 100% to fully recover.
Not surprisingly, corrections typically recover considerably faster than crashes. On average, it takes around five months for a correction to bottom out, but once the market reaches that point and starts to turn positive, it recovers in around four months.
Stock market crashes, however, usually take much longer to fully recover. The most extreme example of the last 100 years was the crash of the 1930s, which took 25 years to get back to its previous high. The S&P 500 took almost six years to fully recover from the crashes of 2000 (the dot-com bubble) and 2008 (the global financial crisis). The S&P/TSX Composite Index (which tracks the performance of companies that make up around 70% of the Toronto Stock Exchange’s value) experienced similar timelines when recovering from those two crashes in the 2000s.
Such long recovery periods for market crashes aren’t always the norm, however. During the early months of the COVID-19 pandemic, the S&P 500 fell in value by 34%, and the S&P/TSX fell by 37%. The S&P 500 bounced back to its previous highs by November of 2020, taking around eight months to fully recover, and had a gain of 15.6% by the end of the year. Meanwhile, the S&P/TSX took just under a year to fully recover its losses.
Thankfully, there are several steps you can take to protect yourself (and your money) from stock market downturns. Let’s take a look at some of them.
How can you protect your portfolio against stock market volatility?
Losing 30% or more of your portfolio’s value can be damaging for anyone, but it can be extremely problematic for investors who are retired or are about to be. It can lead to what is known as the sequence of returns risk, which can have an impact on how long your savings will provide you with retirement income.
The following strategies can protect your portfolio from the dangers of stock market volatility, so that your losses are less dramatic, and your financial plans stay on track.
Keeping a diversified portfolio: invest in a wide variety of assets. This includes stocks and bonds across different geographical regions and asset classes (groups of investments that have similar characteristics), plus alternative investments (such as private equity, infrastructure and real estate investment trusts). Different types of investments can have low correlation, meaning they don’t move in sync with each other. When one asset class declines, others may hold steady or even rise, reducing the overall impact of market declines on your portfolio.
Don’t try to time the market: avoid the temptation to cash out your investments when the market dips. It’s much wiser to regularly invest in a well-diversified portfolio (a technique called dollar-cost averaging). By investing sytematically over time, you can smooth out the ups and downs of the market. When markets rise, your investment grows, and when markets fall, you’re able to buy more units of investments for the same amount of money. Over time, this approach can enhance the compounding effect of your investments and help eliminate the emotional stress of trying to time the market.
Be sure to rebalance your portfolio: a long period of growth for equities can skew the balance of your portfolio towards riskier assets. By selling some of those growing equities and replacing them with less risky investments, you’ll minimize the impact of a stock market downturn.
Look for investment options that offer downside protection: there are various investment products with a proven track record of protecting portfolios from the effects of a stock market downturn. Your IG Advisor can suggest the most suitable options for you.
How to minimize the risk in your portfolio
If you’re worried about stock market volatility or are close to retiring, your IG Advisor can build a portfolio that not only minimizes the risk of stock market downturns but also suits your goals and fits in with your financial plan.
Investments are only one part of the IG Living Plan, a financial plan designed to help you reach your goals faster. Your IG Advisor can build a portfolio that’s designed to minimize stock market volatility while still achieving the growth you need.
Talk to your IG Advisor today about protecting your portfolio from stock market downturns. If you don’t have an IG Advisor, you can find one here.
Written and published by IG Wealth Management as a general source of information only. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on your specific circumstances from an IG Wealth Management Consultant.
