What to Do When the Market Turns

Most investors are optimistic by nature. But no matter what cycle of the market we are in, some sourpuss will find a way to dampen the mood. The latest dire news is that stocks are headed for a protracted fall.

Why? The housing bubble, the inverted yield curve, China -- you name it. Apparently, things have been too good for too long, so we're due for at least a market pullback, if not outright recession.

Of course, no one knows when or how significant "corrections" will happen, but all the dire predictions are right on one point -- it will happen sometime. So let's assume a drop is imminent -- what's your plan to deal with it?

Disaster preparation
The way I see it, stock investors have a few basic options:

1. SELL! SELL! SELL!: Succumb to panic, cash out all your stocks, and sit on the sidelines waiting for a brighter mood.
2. Limit your exposure: A fancy catch-phrase that means sell some of your stocks and put the money in a defensive investment.
3. Do nothing.

Of course, the actions we take with our investments depend heavily on our individual situations -- and they should. Someone close to retirement or relying on fixed income from investments will make different decisions than a young, single worker with income to spare. But while individual situations should influence what actions you take in your portfolio, predictions or emotion should not dictate when you take them.

Buying or selling based upon recent macro events means one thing -- you're trying to time the market, which is never a recipe for long-term success. The important point here is this: Investment plans should be made before any market rises or falls with full knowledge that there will be periods of both ahead of you. This longer-term focus goes a long way to buffet a portfolio from market downdrafts and create incredible wealth for those with fortitude in times of panic.

Put history on your side
Consider the devastation encountered when the dot-com bubble burst in 2000. The technology-heavy Nasdaq market lost more than 60% of its value in the two years following its peak on March 10 of that year. Certainly, a case could be made that the market was way overpriced and investors should have sold -- or at the very least "limited their exposure," particularly to pricey tech stocks.

But what if someone had planned a portfolio that included a few of the larger and more popular Nasdaq companies only two years earlier and simply held them according to a long-term plan? While the bubble burst looks bad from one perspective, the bigger picture is not so bleak:

Even the worst stock, Microsoft, returned 11.9% annually over these four tumultuous years when the Nasdaq index returned essentially 0%. Now granted, these examples were fundamentally sound companies that showed good potential in the long term. Had you gone all in on Pets.com or other highfliers, the results are not as good.

Plan to do what you plan
So what should you do when the market turns? In short, follow your original plan. Whether your original strategy was to be reallocating or even buying more stock at this point, emotional panic is not a good reason to alter a solid plan. If you don't have a plan to begin with, work on that first. Plans are never perfect, but they are usually much better than no plan at all.

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Fool contributor Dave Mock is a glass-half-full kind of Fool and always looks for ways to blow sunshine up someone's skirt. He owns shares of Intel. The cheery Fool is also author of The Qualcomm Equation. Yahoo!, Dell, and eBay are Stock Advisor recommendations. Dell, Intel, and Microsoft are Inside Value recommendations. Calm, cool, and collected, the Motley Fool's disclosure policy never wrings its hands or sweats profusely.