The Motley Fool: When the market tanks, stay calm

Why do market corrections upset us so much? Here are two reasons: We hate losses more than we like gains, and corrections tend to be fast and big. The market might spend a year going up 20 percent, only to give up three quarters of that gain in a few trading days. The downward spikes happen so quickly that we fear they’ll keep going all the way to the bottom, even if we know that that’s very unlikely.

Selling on market dips is usually a bad idea, even if it is human nature. Not only do you lock in a loss, but you also pass up good buying opportunities.

Here’s what to do when the market slumps:

“ Don’t panic. The market has always recovered. Odds are high that it’ll recover this time, too. Remember that your investment horizon is years away, and corrections are often over and gone in a few weeks. Unless your reason for owning a stock has fundamentally changed, there’s no good reason to sell — even if the dip drags on for several months.

“ Remember that sometimes a recovery happens more quickly than the correction did — and even during the correction, prices will bounce up and down.

“ Look for buying opportunities. It goes against our nature to plow more money into the market when things are looking bad, but for a buyer, a correction means that stocks are on a storewide sale. So take a look at your favorite stocks (or mutual funds) and see whether you can grab some bargains. Sure, they might go lower — but even if you don’t get the lowest price, you can still set yourself up for good long-term gains.

If all else fails, just go to the beach. Seriously: If you’re fully invested in good stocks, there’s really no need to do anything. If you built your portfolio using sound investment principles, those principles are still sound, even if Mr. Market is having a tough month.

Ask the Fool

Q: Who determines the “anticipated earnings” for upcoming quarters that I often run across online? Are they just guesses? Don’t they put pressure on companies to perform? When companies fail to meet the predictions, they often get punished. — O.F., Erie, Pa.

A: Earnings estimates usually reflect the consensus of Wall Street analysts, who have traditionally been given guidance by the company’s management. Company bigwigs will frequently, in their quarterly earnings reports and elsewhere, state their earnings and revenue expectations for the coming quarters or years. In the past, they would often disclose information privately to selected parties, but that’s a no-no now, thank goodness.

Information on earnings expectations can help investors crunch numbers to come up with estimates of a company’s fair value. But you’re quite correct — too much attention is given to quarterly results. For long-term investors, the most important thing is how a company will perform over the coming years or decades, not what analysts expect will happen in the next three months. If you’re aiming to hold on to a great company for a decade or more, the two numbers that will determine your ultimate gain are the price you bought at and the price you sold at, not the stock’s price every three months.

My dumbest investment

In my younger years, a guy I played racquetball with talked me into investing in a pepper farm in Mexico. He was supposed to fly me down to Mexico to survey the operation, but that never happened. Needless to say, the investment went under, as well as the salesman (my ex-racquetball partner), whom I never saw again. — R.B., Morgan Hill, Calif.

The Fool Responds: This is a great warning about how we should all be wary of any seemingly amazing investment opportunity that anyone tries to sell us. When we deal with publicly traded stock in American companies, we can take comfort in the fact that they have to report on their progress quarterly, including audited annual reports.