Don't panic!

The recent volatility in the market, coming only a year after the bottom of the most vicious bear market in recent memory, spooked many investors.

Many asked themselves, "Why would I want to leave any money in the stock market, where months -- or even years -- of gains can be erased in a single day?"

These investor jitters are understandable, and we remember the same phenomenon after the bear market of 2000 - 2002. However, it is exactly during such turbulence that a business focus, rather than a market focus, is most valuable to investors.

Back in November, 2009, we illustrated this very issue with a post entitled, "Would you sell your successful local restaurant because of a debt hiccup in Dubai?" At that time, markets were reeling over a debt crisis in the tiny Arab Emirate of Dubai -- a debt crisis that most investors have now forgotten all about, by the way.

While Dubai was a serious matter for the parties involved, we noted that it would be foolish for a local businessman to sell his successful business which he had spent years building just because of some panicky headlines about a situation on the other side of the globe.

Similarly, investors who own shares in well-run, growing businesses would be foolish to sell those shares because of a market gyration caused by concerns about Greece's overly generous welfare promises to government employees (unless those businesses are directly involved with doing large amounts of business with the Greek government).

This is part of the larger point we have made many times before about owning growing businesses through market cycles. This is not to say that investors should "buy and hold" -- far from it. Rather, we urge investors to make their capital allocation decisions based on the performance of the business, not the performance of the market.

As the chart above shows, the recent market gyration was severe, but investors who have ignored the day-to-day fluctuations were probably well served by remaining calm. While we are sympathetic to investors who fear that they can "lose all their gains for months or years in a single day," in fact they only really lose those gains if they sell into a panic (the fact that many investors, and their advisors, succumb to such fears is a key element in the consistently poor long-term performance captured in the Dalbar study year after year).

The markets are back up after it has become clear that Europe and the IMF will create a "safety net" for Greece and other irresponsible borrowers. There are potential inflationary consequences to this path, and we have written many times before that in an inflationary environment, owning innovative growing businesses is an essential foundation for preserving wealth. Investors should understand this perspective, and return to it when short-term gyrations generate that feeling of approaching panic.

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For later posts on this same subject, see also: