Stock market rebounds after S&P 500 slides into a correction. What's next for your 401(k)?

If you're taking a nervous peek at your 401(k) following the stock market's recent plunge, you're not alone.

Wall Street's roller-coaster ride continued Monday. All three major stock indexes gained more than 1% by the close of trading, buoyed by strong earnings from McDonald's Corp. and an announcement that Western Digital Corp. would spin off its flash-memory business. The S&P 500 had ended last week down more than 10% from its most recent high in July, which put the stock index in correction territory, a worrying milestone for millions of Americans who invest in one of the many mutual funds that use the index as a benchmark, mirroring its performance. 

The index, which includes 500 of the leading publicly traded companies in the U.S., ended at 4,117.37 on Friday, down 10.3% from its recent peak on July 31. The tech-heavy Nasdaq Composite index, which entered a correction earlier in the week, closed at 12,643.01.

Stocks have fallen the past three months as investors face the reality of higher interest rates, with Federal Reserve officials talking about keeping rates “higher for longer.”

While the plunge in the S&P 500 may have people fretting over their 401(k)’s performance, market experts say investors should keep in mind that dips are often short-lived.

“Although the last three months haven’t been fun for investors, it is important to remember that corrections are normal and they happen quite often,” said Ryan Detrick, chief market strategist at financial services firm Carson Group.

What is correction territory?

Corrections take place when a market experiences a drop of at least 10% from its most recent peak, a sign that investors are skeptical of what lies ahead for stocks.

It’s more severe than a pullback (typically a short-lived drop of less than 10%) but not quite a bear market (a drop of 20% or more, which can result in significant losses for investors.)

Corrections take place every couple of years, on average, including during the bull run between 2009 and 2020.

Why has the stock market fallen?

The plunge comes as soaring Treasury yields make bonds more appealing for investors, who are getting out of stocks now that the 10-year bond recently exceeded 5% for the first time since 2007, and amid various economic and geopolitical concerns like the escalating tensions in the Middle East.

Detrick said that while the recent weakness has hurt stocks, investors should remember that between January and July, the S&P 500 notched its best first seven-month performance at the start of a new year since 1997. And that "some type of 'give back' wasn’t overly surprising."

What does a correction mean for me and my 401(k)?

Investors should remember how quickly the market tends to recover, according to Sam Stovall, chief investment strategist at investment research and analytics firm CFRA Research. He said pullbacks tend to take about a month and a half to get back to breakeven, corrections take four months and bear markets with a drop between 20% and 40% take 13 months. 

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Will the stock market recover?

“The phrase that they should keep in mind is, ‘This too shall pass,’” he said. “If an investor does not have 13 months, they probably should not own stocks.”

If investors do take some sort of action while the stock market is down, Stovall suggested they should consider:

◾ Rebalancing their portfolio.

◾ Buying high-quality stocks that have fallen in price with the market.

◾ Tax loss harvesting, which means selling stocks that are losing money and using the loss to offset capital gains or profits made from other holdings.

But his final suggestion?

“Sit on your hands. Because the last thing you want to do is make an emotional decision," he said. "You want to make sure that you stop your emotions from becoming your portfolio's worst enemy.” 

Contributing: The Associated Press and Daniel de Visé