Get Ready for a 25% Drop

My friend swears he's learned his lesson.

Back in July 1995, this friend -- let's call him Charlie -- bought Microsoft at what turned out to be the highest price it would see that year. The stock was down 15% in no time, and Charlie was worried. He was smart enough to know the market is the best wealth-creating machine available to us regular folks, but stocks to him were sort of like husbands to Elizabeth Taylor. He liked them well enough, but he tended to give up when things got a little rocky.

In a matter of weeks, his paper loss was approaching 25%, and he couldn't stand it anymore. He bailed out.

Needless to say, the next few years were even rougher on Charlie as he watched Mr. Softy march steadily higher. It achieved 10-bagger status at the height of the bull market in 2000, but even today -- in another brutal market -- it's more than 250% higher than when he sold.

The ups come with downs
As Tom and David Gardner tell their Motley Fool Stock Advisor members, you have to expect significant dips from some of your stocks, and you must remain firm if you've done your homework. Otherwise, you sort of screw up that legendary investing formula by buying high and selling low.

This table should really drive home the point for you. Look at these true all-star performers from the past decade -- a period in which the S&P 500 is down over 30%:

Company

10-Year Gain

Largest Drop

Celgene (Nasdaq: CELG  )

1,261%

79%

Caterpillar (NYSE: CAT  )

114%

73%

Barrick Gold (NYSE: ABX  )

154%

63%

Valero (NYSE: VLO  )

195%

82%

Nvidia (Nasdaq: NVDA  )

360%

88%

Mosaic (NYSE: MOS  )

229%

84%

Realty Income (NYSE: O  )

122%

50%

Data from Capital IQ, a division of Standard & Poor's.

The largest drop for some of these companies happened in the current bear market, but this is a lesson that practically all of the great performers from the past decades have dropped at least 25% at one time or another. It would be very hard for you to find one that hasn't.

The current market is a painful reminder of that. And hey, I'll be the first to admit that many stocks drop 25% and keep dropping. That can happen when a business that has no real competitive advantages to begin with gets the rug pulled out from under it. It happened to me several years ago, and like a shell-shocked boxer, I still duck when I hear the name CMGI. (Shudder.)

Lesson learned
We've all learned some things throughout the years. But if, as Tom Gardner says, you can invest for decades, add money to your existing holdings steadily over time, and stay committed to focusing on truly great businesses, you stand to make a fortune -- especially in the fear-based environment of the current market.

For the seven years since Stock Advisor was launched, Tom and David Gardner's recommendations have beaten the S&P 500 by an average of 50 percentage points. Interested in finding out which stocks to start with? Try a no-obligation 30-day free trial and you'll see Tom and David's five best buys for new money now. Here's more information.

This article was originally published on Jan. 8, 2007. It has been updated.

Rex Moore lathers and rinses, but never repeats. Of the companies mentioned in this article, he owns shares of Microsoft. NVIDIA is a Motley Fool Stock Advisor recommendation. Microsoft is an Inside Value selection. The Motley Fool has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (16)

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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 November 20, 2009, at 9:19 AM, Nickleback99 wrote:

    I think we all get it about buy low, hold on for the ride, don't fall in love w/ your stock and sell high....but relative to this article, are you saying prep for an imminent 25% drop in your estimation, since today promises to be bloody w/ the Dell losses at top of news?....or is your warning to be ready to ride out any drops, whenver they might occur? Pls clarify.

    As for now, I'm glad I bought some significant Put options lately, since this market has no real underpinnings to make this rally last!

  • Report this Comment On November 20, 2009, at 9:56 AM, LloydBraun wrote:

    specious crap!

    with far less risk than equities, bonds have outperformed stocks over the past 10 years and the past 20 years.

    if you think an amateur (or even professional) investor will out perform the market in the long run by the anecdotal method describe in this story, you aren't a "FOOL", you are a SUCKER who does not understand simple statistics.

  • Report this Comment On November 20, 2009, at 11:15 AM, BergyUK wrote:

    Gobbledeegook! What seem like good advice fails to convey its intended message!

    A common mistake when people try to explain something is not to take into account the the explainee doesn't actually know what they are talking about in the first place. State you message clearly:

    Tell em what you are going to tell em, tell em, then tell em what you told em. = Intro, explanation, conclusion. Simplezzz.

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