The last time the stock market experienced a crash of the size and scale recorded in the first quarter of 2020 was during the global financial crisis in 2008 to 2009.
In this article, we will look at how Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) Chairman Warren Buffett (Trades, Portfolio) reacted to the market crash in his annual letters to shareholders, which provide investors with insight into how best to capitalize on low stock prices, as well as how to position their portfolios for a recovery in prices in future years.
Cash reserves
Investing all of your spare capital while stock prices are relatively low may seem to be a good idea for long-term investors. The return potential of stocks is likely to be much higher than cash savings in an era where interest rates are set to remain low as the Federal Reserve seeks to support the economy through injecting unlimited liquidity.
However, Warren Buffett (Trades, Portfolio) keeps a large amount of cash available at all times, as he wrote in his 2008 letter to Berkshire Hathaway’s investors:
“We pay a steep price to maintain our premier financial strength. The $20 billion-plus of cash equivalent assets that we customarily hold is earning a pittance at present. But we sleep well.”
Not only does holding cash provide peace of mind, it also allows you to capitalize on continued declines in the stock market. This may enable you to access even lower stock prices and wider margins of safety further down the line, should investor sentiment continue to weaken.
Investing in stocks
Keeping some cash available does not mean avoiding investing in stocks. They may decline further in the short run and exhibit high volatility, but over the long run they are likely to outperform other assets.
Therefore, following Warren Buffett (Trades, Portfolio)’s advice from 2008 could be relevant for investors at the moment:
“Though the path has not been smooth, our economic system has worked extraordinarily well over time. It has unleashed human potential as no other system has, and it will continue to do so. America’s best days lie ahead.”
It may be difficult to remain optimistic about the outlook for the U.S. economy when unemployment is rising and consumer sentiment is weak, but by investing in quality stocks today, you can position your portfolio to benefit from likely economic growth in the long term.
Predicting market movements
Attempting to predict the direction of the stock market over future months is fraught with difficulty. It is largely reliant on news updates, which are impossible to accurately estimate in the short run.
It was a similar situation in 2008, when the global financial crisis was causing stock prices to experience a large degree of volatility based on news releases. Warren Buffett (Trades, Portfolio) did not try to estimate the short-term movements of stock prices, writing in his 2009 letter to shareholders, “Neither Charlie Munger (Trades, Portfolio), my partner in running Berkshire, nor I can predict the winning and losing years in advance.”
Instead of aiming to accurately foresee the short-term movements of the stock market, buying and holding quality businesses could be a better idea.
Stocks can experience disappointing returns at times over the long run, but their overall capital growth is likely to be positive. Therefore, it makes sense to buy them when they offer good value for money and hold them over an extended time period.
Adopting this strategy during previous market crashes would have yielded positive returns for investors who bought a diverse range of stocks. Doing likewise in the current market crash could lead to a similar result in the long run.
Disclosure: The author has no position in any stocks mentioned
Read more here:
- Investing After the S&P 500's Rebound
- Charlie Munger's Advice on Buying Stocks
- Howard Marks' Tips on Investing in a Volatile Market
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