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Fear: An investor’s worst enemy and closest ally

Fear is a powerful factor in the stock market. During times of economic uncertainty, investors are driven by their fear to sell their shares to restrict their losses.

In June 2012, the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) sharply fell amidst economic fears relating to the Greek Financial Crisis and signs of a major oncoming global recession. Despite the economy having experienced countless dips and dives in the past, headlines once again indicating that ‘this time it’s different’ – the four most dangerous words in investing, according to Sir John Templeton. In response to the pessimism across the media, fear levels in the finance world grew ever higher.

To quote Warren Buffett, ‘Be fearful when others are greedy, and greedy when others are fearful’.

Following the simple logic of the most successful investor of all time, investors should have been relishing the economic downturn – accepting temporary declines in portfolio value, whilst purchasing other stocks at majorly discounted prices. Investors should have been buying during this period, rather than selling.

Pessimistic headlines and forecasts caused dips in large and small companies alike. From the beginning of May, blue-chip stocks such as BHP Billiton (ASX: BHP) and National Australia Bank (ASX: NAB) fell sharply. With decreased investor sentiment, companies such as Myer Holdings Limited (ASX: MYR) and JB Hi-Fi Limited (ASX: JBH) followed closely behind. It is this fear and pessimism that investors experience during such downturns that restrict them from the potential long-term riches and market-beating returns.

The wise investors however, embrace the market’s pessimism. Whilst there were certainly concerns in the retail and mining industries, these investors put their faith in the management of these companies – increasing their exposure to the market and licking their lips at the bargains that Mr. Market was offering them.

They have since reaped the benefits. Since its dip below 4,000 points in June 2012, the S&P/ASX 200 has been on a steady incline, sitting at 5,030 points as of late February. In just over seven months, that is an increase in the index of over 25%. Behind this rapid climb was the recovery of market sentiment and the share prices of quality businesses.

Since their market-value lows in June, three of the companies mentioned above have convincingly beaten the index return, with Myer Holdings returning an astounding 77.6% in eight months. BHP Billiton, falling slightly short of the index, has gained 19.9% since its low.

Foolish takeaway

Fear can convince investors to sell their investments at values far below what the company is worth, or what it could potentially be worth in years to come. In times of economic distress, it is important to remember that a share price only reflects what a person is happy to pay for it on the day, as opposed to a poor reflection on the company itself.

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The Motley Fool’s purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead.  This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Motley Fool writer/analyst Ryan Newman does not own shares in any of the companies mentioned in this article.

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