To say that the stock market has been turbulent lately would be a massive understatement. There have been several days where the stock market has triggered the “circuit breakers,” which automatically halt trading for 15 minutes when the S&P 500 drops by 7% in a single day. And swings of 1,000 points in the Dow Jones Industrial Average in either direction are becoming quite commonplace.
However, crashes like this are an occasional but normal part of investing. Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B) CEO Warren Buffett has an excellent track record of not only navigating market crashes well, but also emerging from them even stronger than he went in.
With that in mind, here are a few pages out of the Oracle of Omaha’s playbook that could help you decide what to do — and what not to do — during these volatile times.
Don’t be afraid to invest
Watching the markets these days can certainly be nerve-wracking. Nobody enjoys seeing the market drop so much in a single day that trading has to be halted or seeing their brokerage account lose a third of its value as the market falls.
However, you shouldn’t let this scare you away from long-term investing. At the very least, you shouldn’t be selling the stocks of solid companies into market weakness, but if you don’t need the money for a decade or more, this could be an excellent time to shop around for bargains.
Market corrections of 10% are common, but 30% market plunges don’t happen very often. As Warren Buffett says: “Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.”
Obviously, don’t invest unless your near-term spending needs are met. And if you’ve lost income or are worried about your cash flow during the COVID-19 pandemic, it’s totally understandable to pump the brakes on putting new money into the market. But if you have money available to invest, it’s a great time to load up on your favorite businesses at a discount.
Beware of value traps
As Buffett has said, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” If a stock has fallen significantly during the coronavirus market crash, you need to decide which of two main categories it falls into:
- Is it a great business that has just been dragged down by temporary issues?
- Is it in serious trouble because of what’s going on in the economy?
Obviously, this question isn’t always easy to answer. But the point is that it’s important to look for businesses that should not only be fine when life starts to return to normal, but that are virtually certain to make it through the tough times relatively unscathed.
Look for a margin of safety
Here’s some advice on how to separate the wonderful businesses to invest in from the fair businesses. One of Buffett’s central investment principles is to look for a “margin of safety.”
A strong brand name, loyal customer base, pricing power, or proprietary technologies or manufacturing processes are all potential examples of a margin of safety.
In the current market environment, however, an important part of margin of safety to consider is liquidity. In other words, does a company have enough money to make it through the crisis, even if it lasts for a while? This Buffett quote sums it up nicely:
“On the margin of safety, which means, don’t try and drive a 9,800-pound truck over a bridge that says it’s, you know, capacity 10,000 pounds. But go down the road a little bit and find one that says capacity 15,000 pounds.”
Let’s say that you want to invest in a hotel stock whose properties are currently closed. If it costs a company $10 million per month to keep the business afloat during the shutdown, a company with just $20 million in cash could only afford to stay in business for a couple of months. But a company with $100 million in cash and borrowing capacity should be just fine, even if their hotels remain closed for much of 2020.
This too shall pass
Finally, although it can be scary when things aren’t going well for the stock market or when the U.S. economy has fallen into recession with no clear end in sight, remember that we’ve been through quite a lot as a nation. As Buffett put it:
“In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts, the Depression, a dozen or so recessions and financial panics, oil shocks, a flu epidemic, and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.”
In a nutshell, stocks are a great long-term investment, despite any obstacles that occur along the way. The path higher for the stock market is more likely to be a roller coaster ride than a steady uphill climb, but over the long run, it’s very difficult to make the case against the stocks of top-quality companies as a great way to create wealth over time.
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