Don't Fear the Dow's Drop

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Many investors are wondering where the good times went. After a supercharged entrance into 2012 had the Dow Jones Industrials Average (INDEX: ^DJI) trading above 13,000, it has fallen almost 10% and looks like it could go below 12,000 -- all the way back to where it was in January. The index is now exactly flat over the last twelve months, leaving investors wanting.

However, as investors, we need to resist our natural instincts to run for the "sell" button. The index still trades up some 16% from the 52-week low it hit in October, and for all of the fear caused by a potential "Grexit" and slowing growth in China, we're in a much better place than we were just a few years ago. Just take a look at the Volatility Index (INDEX: ^VIX) , or "fear index," which is trading at 27.4, up 2.8% today. If you were to take a narrow view, you'd see the index up some 44% in the last month. That's scary stuff. Zoom out to five years and you'll see three towers of terror where the volatility index peaked close to 80 in 2008 and then hit 40 in 2010 and 2011. So things aren't so bad right now.

^VIX Chart


^VIX data by YCharts.

The one thing to remember
As much as we may like to think we can time the market and jump in and out at the most opportune times, we can't. We don't know when it's going to go up or down; we only know that over the long run, it has historically always headed higher. Those upward trends aren't necessarily consistent or predictable, though. The general rule of thumb is that 80% of the returns you receive in risky assets, like stocks, come 20% of the time.

That means you've got to put up with a lot of noise in the meantime. That noise includes big market swings, like what we've seen over the last few weeks.

Today's Dogs of the Dow...aren't.
Just look at today's three worst-performing Dow stocks:

  • JPMorgan Chase (NYS: JPM) , down 3.3%.
  • Caterpillar (NYS: CAT) , down 3%.
  • General Electric (NYS: GE) , down 2.5%.

These three companies aren't exactly super-risky, speculative bets -- in fact, they are three incredible businesses. Caterpillar was our analysts' top Dow stock for 2012 in a recent March Madness competition. JPMorgan is down big after a $2 billion trading loss, but it remains one of the best-run banks out there and trades for an absurdly cheap price-to-book-value of 0.7. Banking is risky, and even the best mess up sometimes, but JPMorgan's loss isn't indicative of a poorly run bank; it's one bet that went bad. Despite running into dividend trouble during the recession, General Electric recently announced that GE Capital will resume dividends to the parent company, and it still remains one of the best places to park your cash if you're an income investor.

No rational investor would sell these companies today, despite drops larger than 2.5% for each of them. That's because over the long run, great companies perform well and rise in price, and you'd be hard-pressed to find a more dense collection of great companies than the Dow Jones Industrials Average. It's no fun to watch the index head lower after falling hard the day before, but take a step back and realize that reacting to daily swings like this is a recipe for destroying wealth.

Making big bets
The seasoned investor instead sees drops like this as an opportunity to take some money off the sidelines and put it to work buying great companies like The Motley Fool's Top Stock for 2012. It's our chief investment officer's favorite stock for this year, and today's price gives investors a rare 20% discount over the last few weeks. Don't drag your feet on this one, because that haircut won't last long. You can read more about this top pick here.

At the time this article was published Austin Smith owns no shares of the companies mentioned here. The Motley Fool owns shares of JPMorgan Chase. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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