Don't Fall For the Market's Head-Fake

No matter how choppy the market gets, you can rely on one thing -- it will tempt you to do the wrong thing.

If you haven't read about it yet, you'll see it soon -- news of another lousy quarter for stocks. The financial-heavy Dow is down more than 7% since April, with all but four of its 30 components down so far this year. AIG (NYSE: AIG  ) and General Motors (NYSE: GM  ) have lost half their value just in the past six months. Meanwhile, broader markets are also hurting, with the S&P down 3% in the past three months and almost 15% since this time last year.

For those of you looking to find a silver lining in all this, I've got some good news and some bad news. The bad news is that if you have a typical mix of stocks and mutual funds, you might freak out when you see how much money you've lost in the past three months.

And the good news? It's too late to do anything about it.

That's good news?
Look, I know it hurts to lose money. But here's a hard dose of reality: Feeling sorry for yourself isn't going to get that money back. What will help you recoup your losses, though, is to get your emotions under control and see where you stand right now, after the dust has cleared.

Think of it this way: Each day, you make a choice with your investments. Whether your stocks go up or down, if you still think at the end of the day that they'll help make you money, then you hold onto them. If you don't, you get rid of them.

So if losses in your portfolio have you ready to throw in the towel on your whole financial plan, ask this question: Has anything you've discovered in the past few months made you change your mind about the long-term prospects for the companies you own? If the answer is no, then why sell now?

Turn around and look forward
The problem is that it's easy to lose your focus on the here and now. Because there's so much information available about past performance, there's a danger of falling prey to what financial journalist Jason Zweig refers to as "hindsight bias." If only you'd bought shares of IBM (NYSE: IBM  ) , Wal-Mart (NYSE: WMT  ) , and Chevron (NYSE: CVX  ) , you may think to yourself, you could've been ahead for the year instead of in the hole.

Now, if you're able to use that past information rationally -- say, by looking for stocks where the market reaction is clearly overblown -- then all those resources are really valuable. But say you're thinking about buying shares of Pfizer (NYSE: PFE  ) at $18 or Baidu.com (Nasdaq: BIDU  ) at $310; does it really matter that one has lost 40% of its value in the past couple of years, while the other has tripled? Those past gains and losses are exactly that -- in the past. What's important is what will happen tomorrow.

So instead of letting the market's swoon convince you to panic-sell all your investments, take a fresh look at stocks. You may well see that everyone else's pessimism has brought share prices of promising companies down to attractive levels. Capitalizing on that opportunity -- rare as it is -- will go a long way toward putting your short-term portfolio losses behind you.

For more on investing through thick and thin, read about:

If you're looking for ways to protect yourself from a harsh stock market, value investing might be the strategy for you. Our Motley Fool Inside Value newsletter recommends stocks with a margin of safety, designed to cushion the blow from down markets while giving you great return potential. Pfizer and Wal-Mart are among those recommendations. See everything Inside Value has to offer free with a 30-day trial.

Fool contributor Dan Caplinger always falls for the head-fake on the basketball court, but he's had slightly better luck in the investing world. He doesn't own shares of the companies mentioned in this article. Pfizer is also a Motley Fool Income Investor recommendation. Baidu.com is a Motley Fool Rule Breakers recommendation. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy plays it straight with you.


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