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Why the Panic Will Make You a Better Investor

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The mad market swings keep coming. If you've seen your portfolio drop by tens or even hundreds of thousands of dollars, you're probably in no mood to look for a silver lining.

But as painful as it has been, you're going to come out of this a better investor. As easy as it is to read simple rules for mastering the markets, you just don't know what it takes to follow through on those bits of wisdom until you experience conditions like these for yourself. Consider these points:

Be greedy when others are fearful
Warren Buffett's advice sounds obvious in a normal up-and-down market. But when times are rosy and everyone's optimistic, it's tough to be the lone naysayer. Last year, Google (Nasdaq: GOOG  ) went over $700 per share, but the consensus was that the search expert was on its way to taking over the computer world. Also-ran Yahoo (Nasdaq: YHOO  ) had a niche for itself, but even the mighty Microsoft (Nasdaq: MSFT  ) couldn't hope to overtake Big G.

If you were fearful while everyone else dreamed of $1,000 Google shares last year, you saved yourself a bundle. Now, Google's value has been almost cut in half, and analysts are focusing more on the negatives of every earnings report the company issues. With scary economic forecasts and their potential to decimate corporate advertising budgets, Google's naysayers now sound prophetic. So are you convinced? Or are you bucking the trend and buying shares?

Use dollar-cost averaging
OK, so you have your inner greed figured out. The next question is harder, though: When there are tons of bargains out there, do you have a strategy for buying?

Stocks have been falling fairly steadily all year. Many thought stocks were attractive down 10%, a steal at 20% off, and crazy cheap after a 30% fall. Yet on Wednesday, the S&P 500 was off by more than 40% from its highs. Did you have any cash left to invest by then?

The only thing worse than not having the nerve to buy low is not having any money to buy stocks with at all. If you've been used to seeing share prices always go up, buying on even tiny dips seemed almost irresistible. After climbing to nearly $150, Research In Motion (Nasdaq: RIMM  ) at $100 seemed great -- but then it dropped another 50% from there. Those who used all of their bullets early are sitting on big losses and can't take advantage of that even better price.

That's why sticking with the discipline of dollar-cost averaging is smart. While shares are dropping, you may feel silly holding back on a bargain. But if shares keep falling, you won't miss out on better bargains by spending all of your investing cash too soon.

Know your stocks
This one also seems basic -- why would you put your hard-earned money into a stock you didn't understand? Unfortunately, the answer is simple: because it made you big profits when times were good.

Remember back in 1999, when people traded ticker symbols and didn't know what companies they owned? That worked fine -- until it stopped working, and plenty of investors were left holding the bag on shares of businesses with no profits and no prospects.

This time around, financials wowed investors with profits from incomprehensible structured assets, while energy companies rode the parabolic wave of skyrocketing oil prices. Shares of Citigroup (NYSE: C  ) rose almost fivefold from 1996 to 2006 and survived the tech bubble relatively unscathed. Energy plays from ConocoPhillips (NYSE: COP  ) to Petrobras (NYSE: PBR  ) emerged from years of below-$30 oil to see their profits multiply.

Yet relatively few had the foresight to predict trouble with the ever-rising housing market. Few had the tenacity to question oil's rise as it hit new records seemingly every day. In the end, though, both were just more examples of a phenomenon stock that investors have seen countless times before. And now, prices will probably overshoot on the downside as well -- yet few have even talked about getting back into energy or financials.

A valuable lesson
If you're like most investors, you've lost a lot of money in recent months. But by now, you've also learned a lot about who you are as an investor. Those lessons, expensive as they've been, will serve you well throughout the rest of your investing career -- and in all likelihood, they'll increase your profits and cut your losses in years to come.

For more on the panic of 2008:

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Fool contributor Dan Caplinger thinks he might be a better investor than he was 20 years ago. He doesn't own shares of the companies mentioned in this article. Petroleo Brasileiro is a Motley Fool Income Investor selection. Microsoft is a Motley Fool Inside Value pick. Google is a Motley Fool Rule Breakers recommendation. Try any of our Foolish newsletter services free for 30 days. The Fool's disclosure policy won't panic on you.

Read/Post Comments (8) | Recommend This Article (19)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 17, 2008, at 7:54 PM, Lexas4 wrote:

    Yep, you hit the nail right on the head there Dan. I for one have absolutely vowed that I will not find myself in this situation again. I will not be greedy when others are greedy and I will never, never run out of bullets again.

  • Report this Comment On October 18, 2008, at 12:16 AM, markwg1 wrote:

    Why people listen to a 78 year old man advice? Internet still didn't exist when Buffett was still a baby!

    Today economic situation is not the same as in the 1940s-1990s (Industrial revolution). We need to know that today's US economy is primarily based on services (> 70% of US GDP). And how many Warren in the world (real successful investor): only 1 person out of 6 billion people).

    In my opinion, companies' revenues and profits cannot go up indefinitely... so it's a waste of time to use the strategies "buy and hold," "P/E," "Book value" in stock markets to buy stocks.

    Best examples: if you invest in stocks like GM, F, GE, YHOO, C, BAC, WB, WM, LEH... 10 years ago... today's returns are less than 5% even some stocks like LEH went bankrupt and GM falling to its 1960s level.

    People are just hopeless about today's economy (Consumer sentiment down, Manufacturing index down, leverages up, debts up, foreclosures up, bankruptcies up, etc.)

    Also the problem we are facing today is probably there are too many women at work... but many of them don't become boss or create jobs... that's may push people salaries lower and make people harder to buy their houses and cars. Take for examples: Bank of America, Citigroup, Microsoft, Apple, Cisco, IBM, Google, Toshiba, Sony, Panasonic, Nintendo, Norton, Garmin, GM, GE, Toyota, Nissan, Kraft, Boeing, Airbus... these companies were founded by men. However, many women just work work work, they don't create jobs or become boss... that may push people salaries lower.

    All the current problems may translate the biggest problems we have seen today since the Great Depression.

  • Report this Comment On October 18, 2008, at 4:17 PM, macrophyllum wrote:

    I agree with you Markwg1, we shouldn't shadow Warren Buffet on everything he says -- be critical. Yes, perhaps there are good bargains to find today, but the reason why Buffet said on Friday "buy American stocks" is because he is so invested. He doesn't want to see things go down careful of people's advice when ulterior motives are lurking. That said, invest wisely and be critical of other investors' advice.

  • Report this Comment On October 18, 2008, at 8:31 PM, Lexas4 wrote:

    The idea that Warren Buffett is worried about his investments and is encouraging us to buy American through ulterior motives is, to be polite, not serious. He is giving good advice, for free. The kind of advice you can find all over this site from other wise investors. My opinion.

  • Report this Comment On October 19, 2008, at 9:02 AM, markwg1 wrote:

    Dear macrophyllum and Lexas4,

    I still don't see today's stocks are cheap to buy! Look at the number of people filling for bankruptcies in Minnesota only:

    I think today's many investors are too optimistics (they still believe all companies' revenues and profits can go up indefinitely, stocks are cheap to buy, etc.) and they still don't understand the "real" problem in this economy there are increasing number of people filling for bankruptcies and foreclosures.

  • Report this Comment On October 19, 2008, at 6:38 PM, USAeconomist wrote:

    People should be conservative with their portfolios. I see many buying opportunities but the market has to price in the bailout plan. Citigroup was one of the banks that lobbied for the ease in lending & changing the bankruptcy laws. Yes they had profits between 2004 & 2006 but lenders should have their hands slapped, they caused this

    Even though bank stocks may seem good but the government is buying into them, they are still plagued with these toxic portfolios.

  • Report this Comment On October 19, 2008, at 8:24 PM, Lexas4 wrote:


    When Buffet says this is a good time to buy, he is not saying you should buy anything and everything. You still have to know what you are doing, stay within your circle of competence etc. Whatever its problems now, the US will recover and then these prices will look cheap. Do you want to buy then or now?

  • Report this Comment On October 20, 2008, at 8:38 PM, simonkathrein wrote:

    Just an opinion... but I would be very careful with "dollar cost averaging". If you are averaging down by buying a stock that everyone once thought was a darling like Nortel, Enron, Bear Sterns, etc. then you've gone broke. Also... Statistically speaking, I believe it was William O'neil that discovered the leaders of the previous bull run are usually not the leaders of the next.

    I do believe in dollar cost averaging a basket of good dividend paying companies, dividend mutual funds, and index ETF's. If a company pays you (in dividends) to own them, then you limit your long term risk greatly.

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