Why Investors Are Wrong

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The past couple of years haven't been much fun for investors. After worries over the devastation on Wall Street and the stumbling economy sent the market into a nosedive, we've seen a huge run-up in recent months. While some observers have predicted continuing volatility, the market's big, quick movements are enough to worry any rational investor.

But as hard as it was for investors to stay in the market during March's plunge, they ended up far better than those who made the mistake of panic-selling. Fools need to stay strong and avoid the mistakes that so many others make.

Running scared
When stocks head south, the logical response is to dump your stocks and head for the hills. No one wants to watch hard-earned money be eaten away by uncontrollable market forces. In this situation, it feels right to do something; just watching from the sidelines can be agonizing. But when investors do take action, they almost always run away from the market.

In fact, in March, at the market's bottom, mutual fund investors withdrew over $27 billion from stock mutual funds. Of this $27 billion figure, $16 billion came from funds invested primarily in domestic equity securities. March's outflows weren't as high as they had been during last fall's panic, but they were still quite significant and exceeded February's levels.

Buy low, sell high
But making investment decisions when stocks are plummeting can lead to some common mistakes. Think back to that classic investing tenet: Buy low, sell high. It's a simple recipe for investment success. But when you start to sell off after a significant market decline, you're violating that very rule. Why would you sell after the price of something has gone down?

The ideal time to sell is at a market peak, or after a stock has had a significant run-up -- the sort of run-up we've seen recently with many stocks, including Bank of America (NYSE: BAC  ) , Freeport-McMoRan (NYSE: FCX  ) , and Mosaic (NYSE: MOS  ) . But it's much harder to sell when your investment has had a good run and you're hoping it will do so again in the future. No one wants to sell when stocks are doing well, but that's the only time it makes sense to do so.

If you have a stock that you liked a few weeks ago at $40/share, you should like it even more now at $30/share. Market dips are an excellent buying opportunity. Stocks are more affordable, and eagle-eyed investors can snap up some good bargains.

It may seem kind of scary to buy when everyone else is selling, but that's the step that most investors miss. Going against the grain during times of market extremes can be an investor's smartest move.

Thinking long-term
Mutual fund investors' last course of action after a plunge should be pulling their money from equity funds to stick it somewhere "safe," like a money market fund.

Many investors have made this exact mistake. But keep your focus on the long term, and try not to let a temporary market plunge distract you.

In fact, if you have some money sitting on the sidelines, panics can be good times to buy quality mutual funds. Whether you prefer growth or value investing, there are funds and ETFs that can make things easy.

For instance, the PowerShares QQQ Trust ETF is up over 40% from the March lows, having owned bounce-back stocks like Research In Motion (Nasdaq: RIMM  ) and Qualcomm (Nasdaq: QCOM  ) . On the value side, an ETF like the iShares Russell 1000 Value ETF gives you instant access to big-name stocks like Chevron (NYSE: CVX  ) and Pfizer (NYSE: PFE  ) .

Living through market downturns and the resulting panic is never fun. Just remember not to think like all of the other sheep in the market. Don't sell off when the going gets tough, and use market downturns to pick up some attractively priced investments. You'll thank yourself for it when the market calms back down.

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Want to find out which mutual funds are right for your portfolio, whatever the market may think? Check out the Fool's Champion Funds newsletter with a free 30-day trial.

This article, written by Amanda Kish, was originally published on Aug. 17, 2007. It has been revised by Dan Caplinger, who owns shares of PowerShares QQQ and Freeport-McMoRan. Pfizer is a Motley Fool Inside Value recommendation. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy always keeps a level head.

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