What to do when the markets tumble?

As Warren Buffett once scribed, “ I call investing the greatest game in the world because you never have to swing. You stand at the plate, the pitcher throws you GM at $47, U.S. Steel at $39, and NOBODY calls a strike on you. There's no penalty except opportunity lost. All day you wait for the pitch you like; then when the fielders are asleep, you step up and hit it!” Longer term, I believe this is absolutely the best investment strategy. Regrettably, participants seem to feel the need to be busy all of the time.

All of our research suggests that Warren Buffett was correct. The logic/math is really simple, even in a worst case scenario. In your portfolio you just buy $1000 of an investment that is trading at $100 a share, and then the market crashes...

Cost and pre market correction value of the security in your portfolio: $1000
After market correction value of the same investment in your portfolio: $500
Adding another $500 to the same investment = Averaging down to $75 per share
The investment you originally made at $100/share, now has an average cost of $75. What's the big deal you wonder? Well it goes like this... Recovering from $50 to $100 requires a 100% gain in the investment. Getting from $50 to $75 requires a 50% gain. It shouldn't require Warren Buffett to tell you that getting a 50% gain is a lot more likely than a 100% gain. If the investment does recover to $100, you will have a 33% gain on your money as opposed to zero by not averaging down.

 

The other major benefit is that the recovery time will be drastically shorter. Add in a dividend or any type of yield and in this scenario you would have increased your income by 50% as well.
The only caveat to this is that you must have confidence in what you own and you must have undepreciated capital to average down with. A properly managed and diversified portfolio would have covered off these issues.

We don't know when or to what degree markets will correct, only that they will. Fearing market corrections is like being afraid of your shadow. Deal with your fear by knowing what to do when the expected happens. If you weren't prepared properly for what we are currently experiencing, don't let your emotions get in the way of making good decisions going forward. Typically the big money is made from the bottom up, not from the top down. Don't be one of the lemmings that lets the market push them around; be the boss.