4 Lessons From The Meltdown

The pain is real. What took years to build vanished in two days. Stocks that slowly improved, week after week, month after month, saw gains disappear in only a few hours. It's shocking. It's painful. And it could happen again.

So what can investors learn from this horrible experience? There are several lessons, all time-worn but nonetheless true. What happened in late 2008 and early 2009 was no less painful, and with this recent disaster, shows that it isn't that unusual. At least not in these perilous times. Here's what investors need to know for the next one, one that will inevitably come but hopefully is many years from now.

1. There are no safe havens. Doesn't matter how big the stock is, how well capitalized or how great management is. When general fear takes over investors' minds, it's often the best stocks that get sold first since they tend to be the ones investors have profits. Most investors sell their winners first and only reluctantly, finally, sell their losers. It should be the reverse. But it isn't.

2. With the knowledge that all stocks are vulnerable, it makes sense to have a wide diversity of them, since some stocks will be hit much harder than others. If you have all your money in one or two stocks, and it's damaged more than most, the pain is much greater. Look at Dendreon for the most recent example.

It had everything going for it: high demand, medicare reimbursement, high profit margins. In fact, they couldn't make enough to keep up with orders. (The company makes Provenge, a prostrate cancer fighting regimen.) But it had never been sold to a broad market. Once physicians began using it, and trying to get reimbursed, they found it was more complex than they wanted to deal with. Orders slowed. The company is now laying off people. And the stock? It went from $40 to $ a day.

3. Markets plummet, fast and unexpectedly. On Friday, the Dow Jones (see our newest article on The Dow Jones Industrial Average in the newly launched OLI Retirement Center) was down over 500 points. Then Friday night, Standard & Poor's downgraded the U.S. credit for the first time. On Monday, at one point, the Dow Jones Industrial Average was down another 600 points. Losing 10% in two days doesn't begin to describe the losses many investors took. Most of us wish it were that small. Individual stocks plummeted by much more. Expect more hammerings and build a portfolio accordingly.

That means broad diversity, among industries and individual stocks. It means buying leaders like IBM, Google, Apple, Wells Fargo, and Intel, stocks that continue to deliver better earnings, even in a difficult economy like we had and have. Not that these won't go down in price when the market crashes. They will. But they shouldn't go down as far (on a percentage basis) as most other stocks because they have attributes investors want. It's just that when fear is the overwhelming emotion, many people simply panic and sell. Most professionals (see Warren Buffett) use these opportunities to buy, which is what he stated he is doing.

4. And that's the last lesson: when all others are selling, it makes sense to look at buying. Not in a big way because no one knows when the economy will really begin to heal (it certainly hasn't yet). But there are very good prices on many stocks that seem to be fairly valued, even more than fairly as many are selling below book value (see Bank of America and Citibank for just two). Should those two banks be bought now? Depends on your tolerance for risk. There's a reason these two suffered more than most when the market cracked. Investors don't believe these banks' troubles are over. And could get worse.

If you start buying small amounts of solid stocks now, when everyone else is selling, most likely you'll be rewarded. If the market continues to fall, it may take a while, but when the market does rebound, your cost basis will be relatively attractive, certainly compared to only two weeks ago.

There will be more terrible days in the market. Stocks will go down very fast. The pain will be real. But if you invest with that in mind, you can bear the suffering much better than most.

- Ted Allrich

August 9, 2011

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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