What Average Investors Should Do In Market Panics and Melt Downs

This post isn’t designed for the active day trader. It’s designed for the average investor. The American that works a job, saves their money for retirement in a 401(k).

You open the newspaper or turn on the business news and you read headlines that are not optimistic. When you look at the economic indicators on a macro level, they aren’t positive. World wide, you see Europe imploding, India slowing, and China slowing. This isn’t a bullish scenerio.
US Unemployment Rate Chart

US Unemployment Rate data by YCharts

Ask yourself a few questions? First, what’s your time horizon? How soon do you need the money? If you are in your early fifties or younger, the odds of you retiring in the next ten years are slim. If you are in your later fifties, you may see retirement coming. Older people should have less money in the market, but now isn’t the time to pull it out.

The second question you have to ask yourself is this, “Am I smarter than the market?”. Everyone thinks they are pretty smart. However, do you know more about a particular stock than the market does? The stock market has millions of players each acting in their own interest on their own information. How are you smarter than all of them combined? The answer is you aren’t.

A long time ago, back in 1965, Eugene Fama proposed a theory. Over the course of time, many academics have tried to puncture his theory. Market analysts and Wall Street types had an economic incentive to disprove the theory. If you follow Fama, you win. You beat everyone else in the market, but you don’t beat the market itself.

Don’t pick individual stocks. Making money in them is like doing heroin. It feels good for awhile, but then the habit gets ever more expensive. Eventually, you lose.

Instead, take your money and put it in a no load mutual fund that replicates the broad indexes, like the S&P 500, the Russell 2000 or something like that. Over the long haul, you won’t lose. You also won’t pay many fees. Investing is practically free.

Once you put your money into a fund like that, ignore the news. Don’t look at the day to day gyrations of the market. Just consistently put money away. When the market dives like it has the past few days, you are buying cheaper. When it rallies like it did earlier this year, you are buying at a higher price. But the sum of your actions will be an even price over time and your money will grow at around an 8% clip. When you are old and gray, you will have a nice nest egg to spend on yourself at retirement.

The problem with this approach is human emotion. All around you there are ads begging for your cash. They try to create uncertainty in your system. Friends at parties may talk about their last big score. This weekend you might hear, “I bought puts on the market and doubled my money.”. Ignore them. Doing things like that is for the pros. Believe me, we don’t make money every day, or even every year. If it was that easy, there would be more of us doing it.

Every year in his investor letter, Warren Buffett gives the same advice I just gave above. He knows markets. Even he doesn’t beat it every year. The reason he does so well is that he buys at a price the market never sees. He also has so much cash, he can afford to buy and sit….for years and years. As a matter of fact, he has no intention of ever selling.

If you are in single stocks, sell them. Take the money and buy the entire market. In twenty years, you will be glad you did.

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11 thoughts on “What Average Investors Should Do In Market Panics and Melt Downs

  1. How is anybody getting a good return long term on their money with indexing?  This advice is so ’90’s.  The return in the article through indexing is now 8%.  Remember when it was 10%.  I think the long tern returns on indexing is going to keep going down.   Blue chip stocks with some indexing to round things out is the way to go.  You will also get a better yield by adding individual stocks to your portfolio and should get an overall better return. 

    1. No, you won’t.  By adding individual stocks you are increasing your beta (risk), your portfolio will have more randomness and volatility with much higher variance. Average investors should just invest in indexes-or themselves by starting a business.

        1. Trust me I ruined my credit learning that lesson the hard way. I thought I was smarter than the market. Invested time and money in a business that I thought I knew alot about. I ended up spending 100k in a business thats breaking even. It’s a successful business it does over 400k a year employs over 10 people but it was still a horrible investment.

  2. Thanks for your words of wisdom… should have done that many years ago… BUT NO as I thought I could beat the market… I ended up picking a wrong fund at a wrong time… take Fidelity international fund for instance… It was sailing higher after the dot com bursted, I, at the time, parked my money in money market after got burnt with technology fund… transferring all my saving to FDIVX and got my butt kicked with 2008 crash.. look at FDIVX and FUSVX now… What you said is correct.

  3. Worst advice ever.  Wall Street has convinced Main Street that we should be 100% invested in the stock market, and then they crash the markets every 10 years.  We’ve had 3 devastating crashes since 87, and we might have another one soon enough.  Meanwhile they keeping making money from fees because we park our money in their “funds”.  So they win if the markets go up, and if the markets go down.  Sounds like another case of Wall Street’s “Heads I Win, Tails You Lose” mentality.

    Unless you want to day trade every day, INVEST IN BONDS.  The inflation fear-mongering is used to drive people into the stock market, but there hasn’t been any real inflation since the early 80s.  And there would be a real return.  Right now with interest rates so low, it’s best to keep your portfolio is shorter term bonds, but as the interest rate increases, you can increase your duration.  But avoid stocks unless you’re willing to play Wall Street’s game of buy and sell. Buy and Hold is dead because you’ll lose you’re money in another crash soon enough, there’s always one around the corner.

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