Now that the market has rallied 200% from its recessionary low, odds are that the market will suffer another sharp drop at some point in the not-too-distant future. That's a scary thought, but remembering the following advice from three of our top Motley Fool contributors could prove to be profit-friendly.
One of the hardest lessons investors have to learn is that the market is almost guaranteed to drop by 20% or more about once every decade or so, and nobody can predict when it will happen.
Research tells us that trying to time the market -- i.e., selling out near the market's peak and jumping back in near the bottom -- is futile. There are too many variables involved, including the dozens of major economies around the world, the hundreds of different industries with their own complications, and the emotions of hundreds of millions of investors.
So what can we do? Use those market drops to your advantage. If you have the fortitude to ride through a financial collapse (and frankly, you won't know for sure until you do it), you'll see plenty of opportunities to invest in great companies at extreme discounts. The hardest part? Holding on to your existing investments and not selling out of fear on the way down.
Not convinced you can do it? Dollar cost averaging might be the answer. Just set up regular monthly or quarterly investments into a core group of stocks or, better yet, a low-cost index fund such as the Vanguard S&P 500 ETF (NYSEMKT:VOO). That way you'll buy shares in every market condition, holding for the long term. Do this for a couple of decades, and you'll see how those market crashes actually helped your returns.
I remember clearly the stock market crash of 1987, and at the time, I was convinced that it meant another Great Depression was right around the corner. Yet as painful as stock market downturns are, you'll find that throughout history, subsequent rebounds have often been quick in helping long-term investors regain their lost ground -- especially when you have cash available to take advantage of short-lived bargain prices for your favorite stocks.
In 1987, it took less than two years for the S&P 500 to return to its pre-crash levels. And even after the 2008 market meltdown, which took the stock market down about 40%, popular benchmarks like the Dow returned to new record highs by March 2013. Those who stuck with automatic investment plans and kept investing managed to earn back their losses even more quickly.
When you're in the middle of a stock market downturn, it's easy to believe that whatever events caused the drop are different from the ones that were so fleeting in past crashes. But so long as you have a long time horizon, a meltdown can be one of the best ways to make money in stocks if you have the discipline to keep investing regularly.
Investing is one of the few areas of life in which you'll find that when everything goes on sale, no one wants to buy. If instead of saying things like "The S&P 500 dropped 10% last month," commentators said, "The S&P 500 is on sale for 10% less than last month's price," people might have a far different attitude toward market prices.
As value investing pioneer Ben Graham quipped, "If you are shopping for common stocks, choose them the way you would buy groceries, not the way you would buy perfume." Mothers are great at finding what's on sale in the grocery store, but they might be hesitant to buy a luxury perfume if it's marked down in price, which can indicate that there's something wrong with it.
If you're confident in a business' prospects for the long run, market meltdowns represent an incredible buying opportunity for those with money to invest. Even if you're fully invested, you can use the opportunity to sell stocks that are highly priced or not fundamentally lacking. You can then reinvest that money into better opportunities, whether that means more undervalued companies or businesses that will compound your capital at a higher rate over time.