Back on Oct. 10, in the midst of the Great Market Freefall of 2008, I wrote an article that encouraged readers to stop and think, to take a moment to acquire a little perspective before frantically dumping their stock portfolios.
It was one of several I wrote during those weeks that pointed at an idea I started calling "Rule 1": Don't panic. Panic is expensive.
It's an important rule, maybe the most important rule for successful stock investing after buy low and sell high. Know your investments, do your research, and don't buy a dead cat bounce all have their place, but panic is a portfolio-killer.
Don't be that guy
Panicked people buy good stocks high (like Vale (NYSE:RIO) at $40) because they're afraid of missing the boat, and sell them low (like First Solar (NASDAQ:FSLR) at $90) to cut their losses. Panic-prone people jump on trends too late and buy "hot tips" from some guy their Uncle Charlie met in a bar, all without doing any research. And when they do do something that's arguably right, like buying big-name stocks like Research In Motion (NASDAQ:RIMM) at $50, they screw it up by selling -- yep, in a panic -- when it hits $43 a couple weeks later.
Panicked investors, in other words, are those who react to events -- specifically, to their emotions about events -- instead of following a plan. They're the essence of the stereotypical "retail investors" that Wall Street brokers claim can't manage their own money.
As with all stereotypes, there's some truth to be found in that one. And in times of crisis, even those of us who are normally pretty sensible can make some big mistakes.
But if you can just remember to follow Rules 1 and 2 before making any trades, you'll come through this crisis in much better shape.
Wait. What's Rule 2?
Rule 2 is so named because it's what you do right after you catch yourself and remember Rule 1, and that is: Follow your plan.
Your plan in any given moment might be as simple as "Buy another 200 shares of Baxter International (NYSE:BAX) if it goes below $50 again." Or it might involve deciding when to sell parts of several positions to reallocate 15% of your portfolio to a bond index fund. It might be a momentary thing -- "If Microsoft (NASDAQ:MSFT) goes back below $20 before lunch, I'm buying some; otherwise, I'll wait until next week and take another look" -- or it might be a complex asset allocation strategy you intend to carefully unfold over the next several decades.
If you're really good at this investing thing, you have all sorts of plans. And you stick to them, because you know that investment decisions made with your rational mind, not your heart or gut, have the best chance of success.
Okay. So, how do I get a plan?
Ideally, your plan will start at a high level and work down, somewhat like this:
- What's your goal? How much money are you hoping to have, and when are you hoping to have it? Are you saving for retirement in 40 years, or hoping for a new boat in five?
- What is the appropriate investing strategy to achieve the goal? This depends on the amount of money you'll need, when you'll need it, and the seriousness of the goal. Retirement investing is a big deal -- you're going to live on that money -- and it requires years of investing, a well-thought-out asset allocation strategy, and so on. Something less serious might be, "I'm going to take my bonus and buy Marvel Entertainment (NYSE:MVL) stock. If it does well, I'll buy a new boat in a few years." But note that even then, there should be a plan -- an idea, based on your ongoing research, of what "doing well" means for Marvel (so you know what to expect and when to sell), some thinking around the boat you want to buy, some buy-in on this whole boat thing from your spouse, and so on.
- What are the steps I need to take now? Do you need growth stock ideas? A corporate bond fund? Tax advice? Whatever it is, do that -- no matter what the market is or isn't doing today.
- If you need to rethink your plan, rethink your plan. Don't chuck it all overboard in a panicked flash because Dell (NASDAQ:DELL) turned in a better quarter than expected, or even because Henry Paulson decided to nationalize your neighborhood deli. Take a deep breath, remember Rule 1, and let your brain take charge.
