The investing landscape seems to have has changed significantly over the past six months. The uncertainty may lead some investors to sell stocks and invest in lower-risk assets such as cash. However, this may compromise most people's long-term returns, in my opinion.
A better idea could be to use a similar approach to that adopted by Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) chairman Warren Buffett (Trades, Portfolio) over recent decades.
Buffett's idea to buy when other investors are fearful, as well as his adaptability to a changing economic outlook, may be key reasons for Berkshire Hathaway’s outperformance over the long run.
Relying on cash
The stock market’s recent volatility has caused many investors to become increasingly fearful about the future prospects for their portfolios. Evidence of this can be seen in the VIX index, which is commonly referred to as Wall Street’s "fear gauge." It has risen from 12 at the start of 2020 to around 28 today.
A possible outcome of being fearful is moving your capital from stocks to less risky assets such as cash. This strategy may outperform the stock market in the short run if it falls further. However, over the decades, holding cash while trying to time the markets is likely to lead to disappointing returns due to the presence of low interest rates.
Having part of your portfolio held in cash can be a logical strategy. It provides you with the opportunity to buy stocks should they fall further. However, relying on cash to produce high returns may be a short-sighted plan.
Buffett is known to hold large amounts of cash, but it is not because he expects cash to produce high returns over the long run. As he once said, “Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value.”
A changing economy
Instead of selling stocks to hold cash, a better idea could be to adapt your portfolio so that it benefits from a changing economic outlook.
For instance, e-commerce companies may benefit from a faster pace of adoption among consumers who have become more used to purchasing goods online. This may create opportunities for investors in online retailers that have the financial strength to adapt to changing consumer trends.
At the same time, some companies that produced rising profitability in the past may be unable to continue to do so in future. This may mean that selling some of your existing holdings to invest in businesses that offer more favorable risk/reward opportunities may be necessary.
As Buffett once said, “The investor of today does not profit from yesterday’s growth.”
Buying undervalued stocks
The investing landscape may have changed over the past few months and could continue to evolve in future. However, a value investing strategy is still likely to deliver high returns in the long run.
Weak investor sentiment and an uncertain economic outlook mean that some quality companies currently offer margins of safety, despite the high valuation of large-caps (which is in some ways hiding the presense of undervalued companies). Buying them now, and holding them for the long run, could lead to an efficient allocation of your capital.
Disclosure: The author has no position in any stocks mentioned.
Read more here:
- Seth Klarman on Managing Your Time Efficiently
- Charlie Munger on Managing Your Portfolio in a Turbulent Market
- Howard Marks on Minimizing Your Losses
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