Stock markets are plunging. Bad news on the earnings front is flowing freely from companies across all industries. Uncertainties have never seemed higher, with a close election vote looming, a financial crisis in Europe, economic slowdowns around the world, and a U.S. economy that has stubbornly refused to push ahead strongly despite unprecedented attempts to get it going.
When situations like this happen -- and they do, more often than you realize -- it's absolutely essential to avoid the mistakes that many investors make under tense conditions. Let's take a look at the biggest problems that plague investors during times like these and what you can do to avoid falling prey to them.
1. Giving in to the urge to act right now.
For the most part, investors have enjoyed a quiet summer. Certainly, the market has moved upward, but it has also moved upward in an orderly way and at a measured pace. What may be hard to remember at this point is that the lack of any meaningful pullbacks during the big rally was infuriating to those who were hoping to get in on the advance at lower prices. As a result, many investors are facing the dual pressure of finally having the long-awaited pullback opportunity they've hoped to get, yet at the same time fearing that buying now could leave them exposed to further losses if the market keeps tumbling.
Whether you've been waiting for a long time to get into the market or are already invested and feel nervous about the pace at which stocks have plunged, acting on instinct will usually leave you regretting that you didn't take more time to make a rational investment decision. Occasionally, you'll miss out on what turned out to be the golden opportunity to buy. Much more often, waiting will give you an ever better chance to get into a stock down the road -- and to feel much more comfortable about it once you finally do pull the trigger.
2. Investing without planning for a whipsaw.
Another common mistake investors make is to let market extremes pull them in one direction, only to get yanked right back in the other one when prevailing conditions change. If you don't have any conviction behind your investing decisions, then you won't know what to do when prevailing wisdom seems to turn on a dime.
For instance, less than two months ago, investors had just seen a big breakout to the upside, and beaten-down stocks had turned upward strongly. In particular, as the situation in Europe seemed to be much closer to resolution, Telefonica (TEF +1.79%) and Banco Santander (SAN +4.33%) had posted some very strong gains. The good news spread across the world, as emerging-market natural resources giant Vale (VALE +3.52%) also rebounded sharply from a recent downturn.
If you bought those stocks looking for the optimism to continue, you're facing a much different situation now. Those stocks all dropped yesterday as worries resurfaced.
To invest successfully, you need to do more than push the buy or sell button. You need to know why you're investing in a particular stock. That way, when conflicting news hits, you'll have a better sense of which view represents the smarter long-term play.
3. Betting the farm.
Panic-selling is an obvious mistake that many people make. But a more subtle mistake is actually more dangerous, because it can seem like the right thing to do until it's too late.
If you're bullish on the market, then you may see now as the perfect time to follow Warren Buffett's advice and to be greedy when others are fearful. But there's danger in getting too committed too early in a downturn. Even after this week's big plunges, the market has only lost between 3% and 4% from its highs earlier this month. If you invest all your money now, then you won't have anything left to invest if we get a full-fledged correction of 10% or more.
Even worse is using margin to invest. When you think you're absolutely right, you may be tempted to follow in the footsteps of Chesapeake Energy (CHK +0.00%) CEO Aubrey McClendon, Green Mountain Coffee Roasters (GMCR +0.00%) founder Robert Stiller, and a host of others by borrowing money using your shares as collateral to take a leveraged position. But remember another saying: The market can be irrational longer than you can remain solvent. Both McClendon and Stiller learned that the hard way, so save yourself some money and define early on how big a position you're willing to buy.
Stay safe out there
Volatile markets are hard to navigate, but by keeping calm, you'll give yourself a much better chance of getting through them unscathed -- or even richer.
Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter @DanCaplinger.
