The past year hasn't been much fun for investors. Worries over the devastation on Wall Street and the stumbling economy have sent the market into a nosedive. While some observers have predicted an imminent pullback for a while now, the market's rapid, deep plunge is enough to panic any rational investor. But in this environment, Fools should stay strong and avoid the mistake so many others are making right this minute.
When stocks head south like they have recently, 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 October, mutual fund investors withdrew over $72 billion from stock mutual funds, marking the single largest week of outflows in more than six years. Of this $72 billion figure, $47 billion came from funds invested primarily in domestic equity securities. October's outflows even surpassed the previous record high of $52 billion in July 2002. You can say this much for U.S. investors -- they really know how to panic.
Buy low, sell high
But making investment decisions in a panic 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. But it's much harder to sell when your investment has had a 45% gain in the past 12 months, and you're hoping it will do so again this year. 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 most investors miss. Going against the grain during times of market extremes can be an investor's smartest move.
Mutual fund investors' last course of action in this sort of environment should be pulling their money from equity funds to stick it somewhere "safe," like a money market fund.
According to the data above, many investors are making this exact mistake. 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, now might be a good time to put that cash to work in a quality mutual fund. Whether you prefer growth or value investing, there are funds and ETFs that can make things easy.
What to do now
If you are looking for an inexpensive entry into the growth corner of the market, you might want to consider the PowerShares QQQ Trust ETF
On the value side, an ETF like the iShares Russell 1000 Value ETF (IWD) gives you instant access to big-name stocks like ExxonMobil
Stocks such as these stand an excellent chance of outperforming in the near future, and they're all a lot cheaper now than they were earlier this year.
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.