What To Do When The Dow Falls 400 Points

Every once in a while, the Dow takes a dive.  The latest example was last friday when the Dow fell 395 points, or about 3.13%, which was its largest drop in 15 months all the while oil rose $10 to $138 per barrel.  A 3.3% loss in just one day is no laughing matter.  If the Dow fell 400 points every day, you’d be practically broke in a month!  Well, at least that’s what many inexperienced investors will keep telling themselves over and over as they work themselves up in a frenzy.  By the time their blood pressure doubles, they’ve already sold all their stocks and bought gold or bottled water and ammo for when the bombs start falling and the radioactive zombies come out of the woodwork.

It’s Not Going To Happen

The Dow isn’t going to drop 400 points every day.  The Dow probably isn’t even going to fall 400 points twice in the same week.  Stocks are volatile.  They go up, they go down.  The prudent course of action is to ignore the fluctuations.  Selling out after a large drop in panic is the worst thing you can possibly do.  By selling, you miss out on the inevitable recovery not to mention create a huge tax headache for yourself.  Not even the professionals and distinguished economists can predict what will happen in the short term.  By selling, you are basically making the claim you’re more intelligent and better informed by these experts.  Doesn’t seem very wise, to me.

Don’t Buy On The Dips, Either

But selling after a drop isn’t the only mistake people make.  Equally dangerous is pumping more money into the market after a drop without regard for market fundamentals.  While I do think it’s possible for the informed individual to determine the instrinsic economic value of a stock and predict its long-term return potential, I don’t think that holds true for the short term.  Buying on the dips is logically the same mistake as selling after a drop:  that is, your decision is based more on emotion than logic.  “But prices are lower so I’ll come out ahead,” you might say.  Yes prices are lower, but you have no idea what level the market will be the day you would have bought otherwise.  Suppose the market continues to drop.  If you invest regularly (as you should), it is likely you would have gotten a better price had you waited.  The beauty of dollar-cost averaging is that you don’t have to outsmart the market.