A Plan for Getting Back in the Market

There's a bug going around, and I'm afraid that lots of investors just like you have caught it. The fancy name is "terminal paralysis." In layperson's language, it means "being overcome with investing inertia; frightened into a financial catatonic state."

The longer it goes untreated, the worse it gets, until eventually the sufferer succumbs to rigor mortis and -- this is the worst part -- misses out on market rebounds like the one we've seen since March, during which many investors make their fortunes. Here, see what I mean:

• Those who invested in the stock market from 1963 through 1993 -- keeping their money in the market for the entire 7,802 days -- enjoyed an average annual return of 11.8%.
• Those who let short-term volatility get the best of them, thus missing the 10 best up days during those 30 years, clocked in with just 10.2% over the same time period.
• Investors whose money was out of commission for 30 of the best days yielded just an 8% average annual return.
• And what if you missed the 90 best days? Hope you're happy with 3.3%.

Legendary investor Shelby Davis put it most elegantly when he said: "You make most of your money in a bear market. You just don't realize it at the time."

Finding profit in pain and panic
The findings above -- from a study conducted by University of Michigan finance professor H. Nejat Seyhun for Towneley Capital Management -- illustrate that those who stop investing during a downturn (or, worse, pull their money out of the market) are robbing their own portfolios.

Investors who can sit on their hands -- and wait out some sharp downturns (there've been quite a few in the past decade) -- can be handsomely rewarded. The chart below shows a handful of outstanding investments and their 10-year returns from January 1999 to December 2008. The third column spotlights each company's worst annual return.

It probably took a lot of antacids to keep Apple in a portfolio in 2000. And Biogen was certainly the cause of a few sleepless nights in 2002 for some investors who watched the stock get chopped right in half.

Even if you timed your exit perfectly with any of these stocks, that's only half of the equation. You have to time your way back in just as accurately if you wanted to reap the full rewards of an upturn. In other words, you need to be right twice.

With so many great companies sporting bargain-basement prices, you're still not too late for Act II: There's no better time than right now to get your money back to work in the stock market.

How to get your sea legs back
Respected money manager Jeremy Grantham says the only cure for paralysis is a battle plan for getting your cash back into equities -- and the discipline to stick to the plan.

In a letter to shareholders from early this year, Grantham spoke broadly about his company's approach. His company, GMO, has reinvested its cash by taking a few large steps (big investments) instead of a lot of small ones. "A single giant step at the low would be nice, but without holding a signed contract with the devil, several big moves would be safer. ... We made one very large reinvestment move in October [2008], taking us to about halfway between neutral and minimum equities, and we have a schedule for further moves contingent on future market declines."

His company tries to model competing costs (investing too soon) and regrets (missing handsome returns from market rallies) -- something every investor should do. Your plan need not be sophisticated, either. "[A] simple clear battle plan -- even if it comes directly from your stomach -- will be far better in a meltdown than none at all," Grantham says.

Pre-commit to buying bargains
There are several ways to structure your get-back-in-the-game plan. You can dollar-cost average your way in by automatically investing a set dollar amount at the same time every month. Another way to get back on the horse is to invest in thirds -- divide the amount of money you want to commit to an investment and then buy in at three separate pre-set points (e.g. after a 10% increase).

John Templeton came up with a brilliant system to stay out of his own way during heat-of-the-moment decision making -- a system that should sound familiar to most Fools: He kept a "wish list."

Of course the money shrinks have a name for this, too: It's called "pre-commitment," and it's a brilliant tactic to neutralize those pesky emotions in our caveman brains.

If you don't already have a watch list, start one. Put down the price you are willing to pay for great companies and review it on a regular basis. That way, the next time butterflies are doing a number in your stomach, you'll have a concrete plan of action that you can actually follow.

Looking for great stocks? Read why Joe Magyer thinks you should buy stocks just like this one.