Corrections and Bear Markets: The Prozac Lesson

These next two lessons suck.

I mean, the lessons are okay, but the content is awfully depressing. But we are all big boys and girls. As investors, we shouldn’t kid ourselves. Let’s have an honest look at what happens when things don’t go as planned.

By the end of these lessons, you’ll be familiar with all things bad when it comes to investing. You’ll hear many of these words I’m going to talk about thrown around in news broadcasts and articles. Let’s become familiar with them so they are not so scary.

The first two I’m going talk about, corrections and bear markets, relate to the stock market and how much stocks are going down.

What’s a correction?

First of all, what’s with this term? When you hear “correction,” don’t you think that’s something good? I mean, there was something wrong or off, and then there was this wonderful correction that came along and fixed it.

But, in the investment world, a correction is not a wonderful thing.

A correction is when the price of a stock, mutual fund, bond, or index, like the Dow Jones or the S&P 500, drops. But then they get fancy, and say, “Well, not just drops, but it has to drop by 10% or more.” If the Dow Jones drops by 9%, then it’s not a correction. If it drops 10.34%, then magically, we have a correction! It’s kind of silly, but that’s what it means.

But why do they call it a correction?

The thinking is that the market or stock went up in value too much and that when it drops, it is really more in line with the real value. It’s like a little kid running around and being crazy. You give the kid a timeout and then he calms down. That’s the thinking, but it is ridiculous. A correction, really? It’s just a nice way of saying, “Uh, you lost 10%, but don’t worry, because now your investment is at the price it should really be at.” Anyway, that’s a correction.

Next what about bear markets?

You may remember that a bear market is one that what, goes up or down? Bears use their claws and strike down at their opponents. So a bear market is one that is going down. This is almost identical to a correction, but instead of the investment or index dropping by 10%, with a bear market, it has to drop by 20% or more.

So corrections and bear markets focus on how much the stock market is going down.

Yay! How fun! But if you really want to be depressed, wait until the next lesson!

The proceeding blog post is an excerpt from Get Money Smart: Simple Lessons to Kickstart Your Financial Confidence & Grow Your Wealth, available now on Amazon.