How To Prosper In A Stock Market Panic

Posted on March 10, 2014 at 12:23 PM PST by

The stock market panic of 2007 and 2008 was epic, truly a stunning fall. And we’ve almost completely forgotten about it.

And that’s pretty much normal. Investors are an optimistic lot. We tend to believe in progress and that putting money at risk is worthwhile, even a precondition of progress.

The really big problem, however, wasn’t the decline of the stock market. The problem was the many investors who panicked and sold as it fell.

stock market panic

Think through that dynamic for a second: As some investors sold off their stocks, what happened to those shares? Did they get absorbed by the companies that issued them? Yes. Did other investors buy them? Yes.

Which raises an interesting question: If the stock market was in such trouble, why did some investors buy as others sold?

In the case of the companies that bought their own shares, they exercised a simple strategy known as a “buyback” in order to help their shareholders.

The thinking is, the fewer shares there are on the market, the less likely the price will erode over time. Lower supply met by steady demand thus results in firmer, if not higher, pricing.

When a company has cash to spend, it can either issue or raise the dividend, do a buyback on the open market or, if it’s a growth-oriented company, invest in new business.

Any of these three moves helps existing shareholders, which often includes the management itself. A panic just makes it easier to buy.

As for independent investors who bought, they saw the same value opportunity in play. Either they had cash to spend or had already targeted specific stocks at specific prices as “buy” signals. They stuck to their investment plan, that’s all.

Can you, as a retirement investor, begin to think the same way? Sure, but it takes discipline.

  • First of all, you need to have a clear idea of your goal. You should target a return, one that’s achievable and in line with long-term results.
  • Second, it helps to diversify broadly. That reduces your risk of an emotional “sell” response based on a single headline or event.
  • Third, build a portfolio that will reduce your risk while aiming for your return goal.

The portfolio approach is the key. Major institutional investors select a set of asset classes — stocks, bonds, foreign assets, commodities, real estate and cash — and establish ranges for each.

Thinking, and acting, like a pro

If a given class exceeds its range, they sell off the gains. If one falls in price, they use that money and incoming cash from dividends and interest payments to buy while an investment is cheap.

It won’t be as exciting as picking a “winner” stock and watching it bust through expectations. But you are also unlikely to pick a terrible investment and then lose sleep as it slips closer and closer to bankruptcy.

And that’s how the big investors survive these occasional market routs and live to invest another day.