The Dow Jones plunged by more than 500 points on Friday and is officially in "correction" territory, down more than 10% from its peak reached in mid-May. The NASDAQ and S&P 500 are down by double-digits as well. And if Monday's volatile trading is any indication, it doesn't look like the sell-off is over just yet. While a market correction can certainly be frightening to even the most experienced investors, there is one thing you definitely don't want to do sell.
In corrections, many investors do the exact opposite of what they shouldObviously, the point of investing is to buy low and sell high. Unfortunately, many investors let their emotions get the best of them, and they end up doing the exact opposite. When the market has a massive winning streak and everyone is making money, investors are tempted to buy stocks at inflated prices (buying high). And, when the market corrects or even crashes, investors panic and sell when stocks are cheap (selling low).
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This has a devastating effect on the ability of average investors to generate wealth over the long run. To give you an idea of just how dangerous this behavior is, consider that a recent study found that the average investor has averaged a total return of just 2.5% over the past 20 years, while the S&P 500 has returned an average of 9.5%.
In other words, the average investor who started with $10,000 two decades ago would have turned that money into just over $16,000. By simply investing in a S&P index fund, that $10,000 would have grown to more than $61,000.
Now, I'm not saying that you should put your money into index funds, but I am saying that a buy-and-hold approach should be taken during all markets bull, bear, and sideways.
Instead, look for bargainsWhen the market is down, the smartest thing you can do is to hunt for bargains that is, acquire more shares of your favorite stocks while they're "on sale."
Sure, many stocks have fallen for a reason. For example, companies with lots of foreign exchange exposure have seen some profits evaporate thanks to the strong dollar. And, energy stocks should be lower because of the plunge in oil prices. On the other hand, there are lots of companies whose share prices have fallen for no reason other than the overall market sell-off.
It's impossible to know (or even to accurately estimate) where the bottom will be. For all we know, the Dow Jones could fall another 2,000 points or more before this correction is over. Or, the bottom could already be here and things will start going up immediately. Nobody knows.
However, nobody ever went broke by acquiring shares of rock-solid businesses at good prices and there is no better time to do this than during a crash. After all, people who had the presence of mind to buy during the 2008-09 crash could have bought shares of Google for as low as $124 ($644 today), US Bancorp for $8 ($43 today), and Starbucks for $3.50 ($53 today). None of these companies were ever in danger of going bankrupt, yet were trading at fire-sale prices just like the rest of the market.
The same logic applies today, although the "sale" isn't quite as good. US Bancorp is still one of the most solid banks in the business, with excellent asset quality, strong growth, and some of the best profitability metrics in the business. Warren Buffett has been a fan of US Bancorp for some time now, and for good reason -- it consistently delivers for investors in good markets and bad. Starbucks has grown tremendously, and is still putting up growth-stock like numbers. During the past year, revenue has increased by 28%, and the company is on pace for its most profitable year yet. And, during the bad times, Starbucks' low debt levels and fiercely loyal customer base will allow it to survive anything the market throws at it.
Finally, Google has a dominant market share in its core business, and has almost no debt to weigh on it if times get tough. Now, I don't want to say that Google's business is "crash proof", but how many other large-cap companies can say they grew their revenue by 77% between 2007 and 2010?
The real money is made during the bad times Look, I get it. My own portfolio is down by more than 10% over the past couple of months, and it's not fun seeing all of those red numbers on my monitor in the morning. However, these are the times when long-term wealth is really created.
To illustrate this idea, consider the investment style of Warren Buffett hunting for stocks of great businesses at bargain prices that he plans to hold forever (Of course, it's a little more complicated than that, but that's the basic idea). It's common knowledge that Buffett has produced some of the best long-term results in history, but many don't realize that Berkshire Hathaway's investment portfolio often underperforms the market particularly in years when the S&P performs strongly. However, the S&P 500 has finished in the red in 11 of the past 50 years, and Berkshire's investments beat the market in every single one. Over the long term, this is a big contributor to Berkshire's success.
So, instead of panicking and selling your stocks, now is the time to dig your heels in and make some smart moves. It may be scary now, but you'll be glad you did it.
The article The Worst Investing Move During A Stock Market Crash originally appeared on Fool.com.
Matthew Frankel owns shares of Google (C shares). The Motley Fool owns and recommends Google (A shares), Google (C shares), and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.