Get Ready for a 25% Drop

My friend swears he's learned his lesson.

Back in July 1995, this friend -- let's call him Charlie -- bought Microsoft at what turned out to be the highest price it would see that year. The stock was down 15% in no time, and Charlie was worried. He was smart enough to know the market is the best wealth-creating machine available to us regular folks, but stocks to him were sort of like husbands to Elizabeth Taylor. He liked them well enough, but he tended to give up when things got a little rocky.

In a matter of weeks, his paper loss was approaching 25%, and he couldn't stand it anymore. He bailed out.

Needless to say, the next few years were even rougher on Charlie as he watched Mr. Softy march steadily higher. It achieved 10-bagger status at the height of the bull market in 2000, but even today it's 380% higher than when he sold -- despite two horrendous bear markets.

Get ready for a 25% drop
As Tom and David Gardner tell their Motley Fool Stock Advisor members, you have to expect significant dips from some of your stocks, and you must remain firm if you've done your homework. Otherwise, you sort of screw up that legendary investing formula by buying high and selling low.

This table should really drive home the point for you. While doing some research earlier this year on top performers from the prior decade, I decided to calculate their largest drops. These were true all-stars, yet investors who bailed on them missed out on some life-changing gains.

 Returns adjusted for dividends.

So, the lesson Charlie learned is that practically all great superstar stocks of the past decades have dropped at least 25% at one time or another. It will be very hard for you to find one that hasn't.

Hey, I'll be the first to admit that many stocks drop 25% and keep dropping. That can happen when a business that has no real competitive advantages to begin with gets the rug pulled out from under it. It happened to me several years ago, and like a shell-shocked boxer, I still duck when I hear the name CMGI. (Shudder.)

Lesson learned
We've all learned some things throughout the years. But if, as Tom Gardner says, you can invest for decades, add money to your existing holdings steadily over time, and stay committed to focusing on truly great businesses, you stand to make a fortune.

For the seven-plus years since Stock Advisor was launched, the Gardners' recommendations are beating the S&P 500 by an average of 47 percentage points each. Interested in which stocks to start with? Try a no-obligation 30-day free trial and you'll see Tom and David's five best buys for new money now. Here's more information.

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This article was originally published Jan. 8, 2007. It has been updated.

Rex Moore lathers and rinses, but never repeats. Of the companies mentioned in this article, he owns shares of Microsoft, which is a Motley Fool Inside Value recommendation. Apple is a Stock Advisor pick. The Motley Fool has a disclosure policy.