Winston Churchill once stated, "Never let a good crisis go to waste." I'm not sure that "good crisis" is the best way to describe the current stock market environment, but Churchill's idea is definitely applicable.
Forward-thinking investors know that the best time to lay the groundwork to earn a lot of money over the long term is during a downturn. Here are three simple steps to make a fortune when market corrections come.
1. Don't panic
The most important step to take for making money during a stock market correction is not to panic. Some people get scared as they see their portfolio balances sink and want to sell all their stocks. That's almost always a huge mistake.
Of course, it's one thing to say, "Don't panic," but putting those words into reality is another story altogether. I've found three things that help me avoid hitting the panic button when my stocks plunge.
First, I try my best not to look at the prices of the stocks that I own too frequently. The old saying that "ignorance is bliss" has some merit to it.
Sure, when the major market indexes are tanking, I know that most of my stocks are falling, too. However, I'm not nearly as anxious when I'm not constantly pulling up my portfolio to see how much I'm down.
On a related note, the second thing that helps me is to remember why I bought the stocks in the first place. Some longtime investors recommend keeping a journal where you write down the underlying premises for buying a stock. I haven't always done that, but it's a good idea. If the reasons for buying a given stock are intact, don't sell -- and don't worry about price fluctuations.
Third, I like to look at a long-term chart of the S&P 500 index. Why? The S&P has had plenty of downturns over the years -- but it has always bounced back. And it's delivered great returns over the long term.
2. Buy the stocks of strong businesses
You've probably heard Warren Buffett's famous statement to "be greedy when others are fearful and fearful when others are greedy" more times than you can count. Just because it's become something of a cliché, though, doesn't mean that it's not great advice.
Buffett also said something else that's just as important to know. In his most recent letter to Berkshire Hathaway shareholders, he wrote that he and his longtime business partner Charlie Munger "are not stock-pickers; we are business-pickers."
I suggest combining these two ideas espoused by Buffett: Buy the stocks of strong businesses when others are fearful. Many investors are afraid right now, so it's the ideal time to scoop up shares of strong businesses.
Sometimes, those stocks have fallen along with the overall market. For example, Alphabet (GOOG -0.96%) (GOOGL -1.10%) is down nearly 30% from its high set late last year. However, its business remains exceptionally strong. The stock trades at a price-to-earnings-to-growth (PEG) ratio of only 0.77 -- a really attractive valuation.
Other stocks, though, have fared quite well during the market correction. As a case in point, Vertex Pharmaceuticals (VRTX -1.35%) is up more than 20% year to date.
The big biotech commands a monopoly in treating the underlying cause of cystic fibrosis (CF). It appears to be in a good position to move into other lucrative markets outside of CF, as well. Physicians will prescribe Vertex's drugs, and patients will take them, regardless of what happens with the stock market or the economy.
The final step to making a fortune when stock market corrections come is probably the hardest one. Once you buy shares of strong companies, the best thing to do next is... nothing. Just wait.
Keep in mind that even a stock that you've bought at a discount could still go lower. Before it became Alphabet, Google in early 2008 fell close to the same amount that it's down now. The stock initially bounced back, but Google's shares didn't keep the positive momentum going for long. The stock went on to plunge by more than 60%.
Some investors who bought back then could have been tempted to sell on the rebound and lock in a modest profit. Others could have gotten scared and sold as Google fell again. However, those who waited would now have a return of close to 770% -- and that's after the recent decline.
Fortunes are rarely made in weeks or months. But they're often made over decades.