The past couple of years have sent investors on a roller-coaster ride. After worries over the devastation on Wall Street and the stumbling economy sent the market into a nosedive, we've seen a huge run-up during much of this year. While some observers have predicted continuing volatility, the market's big, quick movements are enough to worry any rational investor.
But as hard as it was for investors to stay in the market during March's plunge, they ended up far better than those who made the mistake of panic-selling. Fools need to stay strong and avoid the mistakes so many others make.
Running scared
When stocks head south, 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, at the market's bottom in March, mutual fund investors withdrew more than $27 billion from stock mutual funds. Of this $27 billion figure, $16 billion came from funds invested primarily in domestic equity securities. March's outflows weren't as high as they had been during last fall's panic, but they were still quite significant and exceeded February's levels.
Buy low, sell high
But making investment decisions when stocks are plummeting 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 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 -- the sort of run-up we've seen recently with many stocks, including Citigroup (NYSE:C), BHP Billiton (NYSE:BHP), and Ford Motor (NYSE:F). But it's much harder to sell when your investment has had a good run and you're hoping it will do so again in the future. 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 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.
Thinking long term
Mutual fund investors' last course of action after a plunge should be pulling their money from equity funds to stick it somewhere "safe," like a money market fund.
Many investors have made this exact mistake. But 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, panics can be good times to buy quality mutual funds. Whether you prefer growth or value investing, there are funds and ETFs that can make things easy.
For instance, the PowerShares QQQ Trust ETF is up more than 70% from the March lows, having owned bounce-back stocks like Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOG). On the value side, an ETF like the iShares Russell 1000 Value ETF gives you instant access to big-name stocks like AT&T (NYSE:T) and Goldman Sachs (NYSE:GS).
Living through market downturns and the resulting panic is never fun. Just remember not to think like the sheep in the market. Don't sell off when the going gets tough, and use market downturns to pick up attractively priced investments. You'll thank yourself for it when the market calms back down.
Stop being on the wrong side of the market. Rick Munarriz has found five stocks that should beat the market next year.
