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Over the past week, the stock market’s had wild swings with the Dow up and down triple-digits. The bears savaging the market more than the bulls can make it rally back. Now, a lot of investors who’ve done very well since 2008 are worried about what’s ahead for their portfolios. The question on many investor minds is “Do I stick it out through the ups and downs, perhaps with some hedging, or should I just get out of the market, sit on cash for a while and then come back later?” They’re thinking, “What’s really going on with the economy?” America seems to be doing well but a slowdown in Europe, geopolitical turmoil and fears over Ebola appear to be driving U.S. markets down. So what should you do in this current environment of volatility?
Todd Campbell of investment website Motley Fool turned to Warren Buffett’s writings over the years and picked up a few nuggets of wisdom that he thinks could guide us on how to ride out this volatility.
As most of you know, Warren Buffett packs his annual letters to shareholders with lots of folksy wisdom, with real-life examples of situations he faced and what got him through them. So I am going to share Todd’s research with you today.
#1: Buffett wrote in 2013 that “It’s better to have a partial interest in the Hope diamond than to own all of a rhinestone.”
Buffett is always hunting for great companies that he can buy for Berkshire Hathaway shareholders, but if he can’t buy the whole company, he’s okay with owning a smaller piece of it instead. He’s never going to exchange a smaller piece in a great company for full ownership of a not-so-great company. Applying his advice means spending more time on researching your investments before you buy, looking at things like a company’s growth prospects and where it’ll likely be 10 years from now.
#2: In 2010, Buffett wrote “A ‘normal year,’ of course, is not something I can define with anything like precision.”
His point here is that there is no such thing as a “normal” year in the stock market and historical returns cannot be extrapolated into the future. Investors should focus less on the returns for any one period of time and instead focus on investing for the long run. Bear in mind that over extended periods, with no money taken out , the market has soundly outperformed inflation, bond investments and real estate.
#3: He writes, “Long ago, Charlie laid out his strongest ambition: ‘All I want to know is where I’m going to die, so I’ll never go there,’”.
That’s a good one, wish we could all do that in real life, not go where we know we’re going to die, but when you apply that to investments, it’s like saying, “all I want to know is where I’m going to lose money, so I don’t invest there.” That’s a fairly do-able proposition. Research your companies well and stay out of the ones where you could end up losing your capital. Avoid companies that you can’t evaluate over the long run and focus on finding businesses that offer a predictable profit for decades to come.
Speaking of Charlie Munger, at the 2013 Berkshire Hathaway Meeting I heard him say: “If you’re not confused, you don’t understand things very well.” Don’t feel bad if you are confused. It just means you’re normal.
#4: “We will never become dependent on the kindness of strangers. Too-big-to-fail is not a fallback,” wrote Buffett in 2009.
Here, of course, he’s alluding to the crash in 2007/2008 where many big banks were deemed too-big-to-fail. He says that’s not a reliable fallback strategy. Buffett famously hoards cash so he can deploy it when he sees solid investing opportunities or can fall-back on it when markets turn sour or his portfolio companies need monetary assistance. This plan-ahead mentality is something every investor can embrace by making sure there’s always some dry-powder around to deploy during the market’s inevitable declines. I also know many investors like to buy on margin. While margin-buying can be an effective strategy, going all-in and not having enough cash set aside can destroy your portfolio if your investment thesis fails. Having some cash is a good strategy but remember, most of us aren’t like Buffett. That is, we aren’t interested in buying whole companies. I don’t think most individual investors should have a lot of cash sitting around in their portfolios unless they heavily rely on higher-risk investment strategies such as margin investing, shorting stocks, etc.
#5: In 2009, Buffett wrote, “We would rather suffer the visible costs of a few bad decisions than incur the many invisible costs that come from decisions made too slowly — or not at all — because of a stifling bureaucracy.”
Buffett doesn’t hesitate when he’s presented with an idea that hits the mark. He recognizes that he won’t be right every time, but he also believes that taking action is critical to realizing the potential of an opportunity. As investors, we can emulate Buffett’s approach by making sure that once we’ve done our due diligence and picked our favorite investments. We take action and buy, regardless of the market’s short-term movements. But just so you don’t get trigger happy, let me re-iterate a key point I just mentioned: do your due diligence first! Don’t just go out and buy on incomplete information. Then, once you’ve done your due diligence, act quickly so you don’t lose that window of opportunity.
#6: “Unlike many business buyers, Berkshire has no ‘exit strategy.’ We buy to keep. We do, though, have an entrance strategy, looking for businesses in this country or abroad…available at a price that will produce a reasonable return. If you have a business that fits, give me a call. Like a hopeful teenage girl, I’ll be waiting by the phone.”
Most money managers at mutual funds, hedge funds, etc., are always looking for an exit strategy. Buffett looks for good buys, not great exit strategies where he can make a quick buck. He sticks to his investment discipline and is always open to great ideas that fit his long-term investment strategy. Similarly, individual investors should just stick it out and ignore near term volatility.
#7: Back in 2004, Buffett wrote, “Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful”.
This is one quote from Buffett that you’ll hear time and time again, investing in the market is not about excitement and emotion; it’s about discipline and waiting. It’s not about riding the populist wave but playing the wave to your advantage. When prices go below your target purchase price on shares you want to hold for the long run, relish the drop as an opportunity to beef up your positions, and don’t let emotions impact your investments.
Back to the main question – what should you do in this current environment of volatility? I think the answer mostly depends on the type of portfolio you’re sitting on. If it’s built on momentum companies where you’re riding the wave, then I suggest you take your profits and sit on them for a while and wait for a dip to buy great companies at reasonable prices. But if, like Buffett, you’ve done your research well and have great companies in your bag already, don’t be overly concerned with market volatility. Ride out the wave, hang tight, don’t sell. Watch the market carefully and look for opportunities where the companies you love start to trade at prices that seem reasonable and buy on dips.