What you should do in this falling market

Stock market volatility gives you the potential to earn outsized investing returns.

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Great market volatility gives you the potential to earn great investing returns, writes The Motley Fool.

There's always something worrying stock markets.

Today, it's the U.S. debt ceiling – will they or won't they raise it? Our money is on yes, but we could be wrong. Betting for or against politicians is a dangerous game.

Tomorrow's worry? Take your pick from the double-dip recession, deflation, inflation, the high and soaring higher Aussie dollar (AUD), a Chinese property crash, or European debt.

Nothing's truer than the old saying the market climbs a wall of worry.

People hate losing money. Shares are risky, especially in the short-term. Put the two together and it's a recipe for worry.

The Motley Fool advocates investing for the long-term, that being a minimum of 5 years, a maximum of forever. Time is your friend. The miracle is compounding returns.

Perspective, dear Fool

The S&P/ASX 200 index is down around 4% so far in 2011. Not great, obviously.

For investors in companies like PaperlinX (ASX: PPX), Energy Resources (ASX: ERA), CSR (ASX: CSR), Transpacific Industries (ASX: TPI) and Karoon Gas (ASX: KAR), 2011 has been even more painful.

Stating the obvious, you'd have been better off sticking your money in the bank, earning up to 6% interest, at call, thank you very much.

Yet before you despair too much, in these volatile days it pays to put things into perspective.

Whilst many investors would seemingly prefer a steadily upward moving market, a 4% reversal in 2011 to date is nothing to be too alarmed about.

Do we have such short memories as to have forgotten the great run the market had in 2009, rising 35%, excluding dividends?

That's the stock market for you. It's volatile. It's not like leaving your money in the bank, where you are guaranteed a steady return and are guaranteed not to lose money.

For those guarantees, you can earn your 5% or 6% interest per annum.

Or you can put your money in the stock market and earn a non-guaranteed return plus have no guarantees you'll not lose money.

Sounds like a lame alternative, doesn't it? So why do we persist?

One word

Summing up the big attraction of the stock market in one word, we'd use the word "potential".

We have the potential to earn outsized capital returns.

We have the potential to earn outsized returns from dividends.

But, we have the potential to lose money.

Hands up if you're selling everything today? Or hands up if you'll be selling everything if the market falls another 10%?

Don't do a thing

Unless you are forced to sell, because you suddenly and desperately need the money, or far worse, you've borrowed money and your margin-lender wants some of it back, and fast, you are not forced to sell.

Yet many investors have a poor record when it comes to the timing of their buys and their sales.

They tend to buy after the market has already risen, often substantially so, buoyed by the seeming lower risk, and/or afraid of missing out on easy profits.

Conversely, they tend to sell after markets have already fallen. The news flow is often bad, and when markets are falling precipitously, there just doesn't seem to be any end to the pain of seeing your portfolio crater in value. Hitting the sell button gives them an instant dose of investor's morphine.

Embrace volatility

So what action do you take in the face of this falling market?

Hopefully you're already reasonably well positioned, having a decent cash balance after you've sold your weaker holdings.

And naturally, you're mostly invested in high quality companies, preferably of the dividend paying blue chip variety – companies like Woolworths (ASX: WOW), CSL (ASX: CSL), Origin Energy (ASX: ORG) and Incitec Pivot (ASX: IPL) – and you're ready to buy some more shares should real fear and panic hit global stock markets.

Times like these are stark reminders of the volatility of the stock market. But rather than be fearful of volatility, embrace it. It's such volatility that gives brave and knowledgeable investors the potential to buy shares at attractive prices. What can be better?


Read this before the market crashes

Of the companies mentioned above, Bruce Jackson has an interest in Woolworths. The Motley Fool has a solid disclosure policy.

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