How to protect against a market correction

  • The recent correction in the tech sector in the United States has raised fears of a potential wider and larger market pull back

The general view is that there will be corrections in the market, as it is always a matter of ‘when’ and not ‘if’. We believe that it is important to avoid substantial loss in inevitable market corrections. This is because losses are exponential, the larger they are the greater amount an investor needs to make to break even on the original position. If an investor loses 1% of their portfolio, they have to make 1.1% to make it back. If they lose 5%, they need 5.26% to break even. At 10%, breakeven is 11%. A 20% loss requires a 25% gain. If you lose 50% of your portfolio you have to make 100% to make it back. If the unthinkable happens and you lose 90% of your portfolio, an investor must deliver 900% to break even. 

Experienced investors know that making 100% and doubling their money is a lot harder than losing 50%. It is important therefore for investors to have a plan for when a market correction happens. Without a plan, a serious market correction can be like stepping in front of a freight train for investors. It is possible for a portfolio to recover from a small to medium sized loss in time. However, without extra capital it is extremely difficult for investors to recover from a substantial correction. 

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