However, corrections offer an opportunity to evaluate risk and how well positioned they are for an eventual bear market.
By comparing the intensity, recovery and duration of corrections and bear markets and their impacts on investors, we can assess where risk management efforts should focus.
Investing opens investors up to the possibility of losses — but not all losses are equal. Understanding the differences between a correction and a bear market may help investors better handle or prepare for them.
In the past 20 years, the S&P 500 Index has experienced five corrections (not including the corrections occurring as part of the bear markets) and two bear markets.
Corrections are often defined as losses in market value exceeding 10 percent but less than 20 percent and happen from a market high. Corrections have historically lasted from between a few weeks to a few months.
Bear markets are defined as losses in market value of 20 percent or more and have historically lasted several months to several years. The losses experienced in bear markets are more intense and require longer recovery periods on average than corrections.
The intensity of the drawdown measures how much market value was lost. Over the last 20 years, the most intense correction delivered a 19 percent drawdown, and the least intense corrections created a market value loss of about 12 percent to 13 percent.
By comparison, the magnitude or intensity of losses during bear markets are often more difficult for investors to stomach. Although a bear market is defined as losses in value of more than 20 percent, the two in the past 20 years were more than –47 percent — more than double the losses caused by the worst corrections.
The intensity and effects of a bear market are much more painful, especially when we consider time of recovery. Recovery time refers to how long it takes for the market to recoup its losses and return to pre-fall levels. Mathematically speaking, the larger the loss, the larger the gain needed to recover.
The –13 percent drawdown of the 2015-16 correction took about two months to recover, while the –19 percent correction in 1998 took only about three months. The –11 percent drop in 2000, though, took almost five months to recover.