Black Monday

The Stock Market Chamber of Horrors

Be strong. You're about to take an interactive tour of the more gruesome side of investing. But it's not all bad news. Coupled with each of these disasters is a prescription for avoidance—a strategy for defending yourself and maximizing your rewards. Don't miss this special—and highly educational—series.



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Black Monday
from SmartMoney University

The Wall Street Journal headline said it all on Oct. 20, 1987: "Stocks Plunge 508.32 Amid Panicky Selling." For Houston secretary Julie Ianotti, a hard-won retirement nest egg suddenly looked very much in peril. "I'm scared," she told a reporter. "Should I sell? Tell me, should I sell?"

Black Monday made a lot of people feel that way. It sent a wave of dread through a nation drunk on its own prosperity. Fueled by Reaganomics and an easy-money culture, stocks had soared more than 225% between January of 1980 and late summer of 1987. When they plunged 30% in a matter of weeks -- most of it on that ugly 508-point day -- the nation stood still in a collective state of shock. Not since 1929 had Wall Street looked so instantly vulnerable.

A market free-fall is about the scariest thing imaginable for anyone who has put faith in stocks. But that has more to do with fear of the unknown than actual financial damage. It's true that if you had invested all your money near the market's peak in 1987 and held on through the crash, you wouldn't have recovered your losses until August 1989. But the fact is, most people don't invest that way. They tend to put money to work a little at a time, laying aside a part of their paycheck at regular intervals.

Suppose, for instance, that you had invested $10,000 in equal monthly increments of $385 from July 1987 until August 1989. Although you would have lost what you had accumulated by September 1987, your $385 a month would be buying stock that was dirt cheap in late October. As stocks began to rally, you'd be getting the full benefit of the recovery. And when all was said and done, you'd be sitting on almost $12,400.

Investing a little at a time is a strategy known commonly as "dollar-cost averaging." It doesn't shield what you already have invested from a market crash, but it does let you take advantage of the fact that stocks become cheaper as the market declines. Because the amount you invest remains constant, you are able to buy more shares of a stock or mutual fund when the price is low and fewer shares as the price rises.

Investing on dips -- or crashes -- is the hallmark of the experienced investor. It may take nerves of steel at first, but experience will teach you that the market rewards those who buy low and sell high. The worst thing, of course, is to do what most people find completely intuitive when the market tanks -- sell at the first available opportunity. The best advice for Julie Ianotti would have been: "Hold on tight."