A Guidebook for Investing in Down Markets

By Amanda B. Kish, CFA | More Articles
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There's no doubt about it: Investing is an emotional pursuit. 

Keeping your cool is pretty easy when the market is heading up and you're posting double-digit gains each year, but investing in a down market is a whole different animal. When you're watching your portfolio fall into the red, it's easy to give in to fear and panic. But if you follow these simple rules for investing during volatile times, you can reduce some of those emotional tailspins -- and never worry about bear markets again.

1. Don't try to time the market
You've heard it before, and you'll undoubtedly hear it again, but this is one of the most important aspects of investing -- and one of the most easily forgotten. No one, not even the rafts of experts, knows what the market is going to do when. Don't waste your time trying to figure it out.

That doesn't mean you should give up finding great investments that are undervalued, or that have terrific long-term growth prospects -- that's a vital part of the game. But remember that even great stocks can get dragged down by the market from time to time, making short-term bumps in the road inevitable. Keep investing your money steadily, just as you would if we were in a bull market. Over the long run, the stock market has trended upward, so try not to fret over every market correction along the way.

While you can't time the market, you can take advantage of a declining market by snapping up great stocks at discounted prices. Who doesn't love a clearance sale? This year's roller-coaster market has pushed many big-name stocks significantly off their 52-week highs.

A few stocks that have been battered lately but warrant a closer look: Exelon (NYSE: EXC  ) and Time Warner (NYSE: TWX  ) , both of which are around 40% off their 52-week highs. The debt-free likes of Google (Nasdaq: GOOG  ) and Apple (Nasdaq: AAPL  ) are off by more than 50%, despite having strong leadership and plenty of competitive advantages.

If you want to get in on some great companies with a lowered price tag, make sure you keep a long-term outlook, but remember that now might be a good time to go shopping.

2. Keep costs under control
Trading costs and management fees start to loom larger when your investments are losing money. Engaging in frequent trading when market volatility and share-prices losses are on the rise is a surefire way to burn a hole in your portfolio.

The same principle applies to mutual funds. During good times, many people are lured into pricey funds that have posted outsized gains. But as soon as the going gets rough, investors are stuck with paying a ridiculous expense ratio on a fund that's not making them any money.

Many good funds also have low fees, and finding them should be a Foolish investor's priority. If you really want to be a tightwad, exchange-traded funds, with their rock-bottom expenses, are the way to go. Just stick to broad-market diversified funds like the Vanguard Large-Cap ETF (NYSE: VV  ) , which holds more than 750 stocks, including major stakes in Intel (Nasdaq: INTC  ) and AT&T (NYSE: T  ) , and charges just 0.07% in expenses.

3. Know your limitations
A lot of investors felt like geniuses in the late 1990s, when tech stocks were going through the roof. All you had to do was throw money at the latest batch of highfliers, then you could sit back and watch your portfolio double. Of course, when the bubble burst, a lot of people were taken by surprise.

Investing guru Warren Buffett stays within his circle of competency, and so should you. If energy continues to rise, but you understand little about the oil trade, you'd be wise to know your limitations and try not to pick a rocket stock.

Of course, you shouldn't be afraid to look for help. That could mean investing your money with a mutual fund manager who does understand a particular sector or country -- as long as you find tenured and successful managers and keep a lid on fees, of course. Or it could mean subscribing to industry trade publications, or message boards, or even joining a service like my Motley Fool Champion Funds, which offers up a new fund recommendation every month. (You can check us out today with no obligation by taking a free 30-day trial.)

It's tougher to invest in a stormy market than a sunny one, but there's no reason you can't come out smiling in the end.

This article was originally published on June 13, 2008. It has been updated.

Amanda Kish heads up the Fool's Champion Funds newsletter service. At the time of publication, she did not own any of the companies mentioned herein. Intel is a Motley Fool Inside Value recommendation. Apple is a Stock Advisor choice. Google is a Rule Breakers pick. Click here to find out more about the Fool's disclosure policy.