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It's Time for Some Perspective on Stock Market Corrections and "Plunges"

The headlines are unavoidable if you're surfing social media or watching a national news network. On Monday, the stock market "plunged."

Here's just a snippet of the headlines that investors encountered following the weakest trading day of 2019, which saw the Dow Jones Industrial Average (DJINDICES: ^DJI), Nasdaq Composite (NASDAQINDEX: ^IXIC), and S&P 500 (SNPINDEX: ^GSPC) decline by 767 points, 278 points, and 87 points, respectively.

And this list goes on.

A paper airplane made out of a one dollar bill that's crashed onto the financial section of the newspaper.
A paper airplane made out of a one dollar bill that's crashed onto the financial section of the newspaper.

Image source: Getty Images.

The common theme here, aside from focusing on escalating trade-war tensions between China and the United States, is that these headlines imply panic, fear, and uncertainty on Wall Street, as well as with John and Jane Q. Investor at home.

However, this fear is unlikely to be warranted. It's time to add some perspective on Monday's "plunge," as well as stock market corrections in general.

Declines and corrections are incredibly common

Let's start with the basics -- namely, that the stock market doesn't just move exponentially higher or go up in a straight line. Since 1950, there have been 37 separate corrections in the broad-based S&P 500 -- i.e., declines of at least 10% in the index from a recent high -- not including rounding, according to data from Yardeni Research. This implies a correction about once every 1.9 years.

Of course, the stock market doesn't adhere to averages. That means we could go years without a major correction, or face two or more within the same year. Although the indexes are not currently in an official correction -- the major indexes are less than 10% below their recently set all-time highs -- they're certainly within reach of pushing into correction territory with one or more extended down days.

There's a big difference between nominal and percentage declines

Speaking of perspective, it's incredibly important for investors to put into context the scope of Monday's decline. Sure, seeing the Dow Jones fall more than 900 at its intraday worst and the Nasdaq shed over 300 points at its session low might sound and look scary. But on a percentage basis, neither move was even remotely close to cracking the 10 largest percentage moves lower of all-time. The Dow and Nasdaq shed 2.9% and 3.5%, respectively.

Over time, many of the high-quality businesses that are included in all three of the market's major indexes tend to increase in value. As the nominal point value of these indexes increases over time, so will the likelihood of larger nominal intraday point swings. For example, even though a 1,000-point decline might sound terrible for the Dow, it wouldn't even equate to a 4% decline in the Index. While a 3% decline may not be ordinary for the broad-based indexes, it's also far from being a "plunge."

An investor circling and drawing an arrow to the trough of a stock market correction on a chart.
An investor circling and drawing an arrow to the trough of a stock market correction on a chart.

Image source: Getty Images.

Corrections and big declines have always represented a long-term buying opportunity

Big down days in the stock market aren't fun. I get it. But they're also not the end of the world, either.

As historical data has shown, each and every one of the S&P 500's corrections has eventually been erased by a bull-market rally. In many instances, these declines in the stock market were short lived and lasted less than four months. Conversely, it often takes just weeks or months, rather than years, to completely retrace and erase notable market declines.

In other words, if you had bought a diverse basket of high-quality stocks during each and every stock market correction or major single-day decline over the past seven decades, you'd almost certainly have made money as of today.

A majority of the stock market's best days occur very close to its worst days

Every year for the past couple of years, J.P. Morgan Asset Management has released a report highlighting the advantages of staying invested in volatile markets. For its research, J.P. Morgan Asset Management often highlights the aggregate annual return of buying into, and holding, the S&P 500 over the trailing 20-year period, versus what that return would be if you'd missed the 10, 20, 30, and so on best days in the market. As has been consistent throughout its reports, regardless of year, your return would be more than halved by missing the stock market's 10 best days over this 20-year period.

Additionally, it's worth noting that between 50% and 60% of the market's best trading days in this rolling 20-year period occur within two weeks of its 10 worst trading days. This is a fancy way of saying that if you try to time the market in order to avoid increased periods of volatility, you'll likely miss out on some of the biggest rallies, thereby hurting your long-term return potential.

A visual perspective

Finally, how about a visual perspective of what Monday's plunge looks like in the bigger picture?

As you can imagine, it looks downright worrisome when looked at on a weekly chart, as shown below:

^SPX Chart
^SPX Chart

^SPX data by YCharts.

But here's Monday's plunge when compared to the S&P 500's return over the past five years:

^SPX Chart
^SPX Chart

^SPX data by YCharts

And here's a look at the S&P 500 since 1950:

^SPX Chart
^SPX Chart

^SPX data by YCharts.

When things are put into proper perspective, Monday's decline is nothing more than a blip for a stock market that's shown time and again that it's headed higher over the long run.

More From The Motley Fool

Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

This article was originally published on Fool.com