Some investors may feel that the current bull market will last forever. However, no previous bull market has been permanent. In fact, their average length has been less than three years.
In my view, being mindful of a likely fall in stock prices could help you to avoid overvalued stocks and instead purchase quality businesses at fair prices.
Berkshire Hathaway BRK.A BRK.B chairman Warren Buffett (Trades, Portfolio) has a strong track record of performance in a wide range of market conditions. Adopting his strategy of holding cash and focusing on companies with solid fundamentals may help you to prepare for the end of this bull market.
Trying to time the market
Trying to time the stock market is impossible. There are a wide range of factors that can cause prices to move higher or lower. Some of them are known unknowns, while other risks can be impossible to predict. Therefore, trying to work out when the current bull run will end is unlikely to allow you to allocate capital efficiently.
A better idea could be to ensure your portfolio holdings have solid fundamentals and are not currently overvalued. Companies with weak balance sheets may struggle to survive a difficult economic outlook. Likewise, stocks that are currently overvalued may be among those hardest-hit by declining investor sentiment in a bear market.
Selling your overvalued or financially weak holdings may be a prudent strategy. It could help to strengthen your portfolio's performance ahead of a potentially uncertain economic period. As Buffett once said, "Predicting rain doesn't count, building the ark does."
Following other investors
It is tempting to listen to the views of increasingly optimistic investors in a bull market. This may mean that you purchase companies with improving prospects that you do not fully understand. The end result may be that you do not fully take into account future risks.
Therefore, it is crucial to fully analyze a company's fundamentals before buying it. This may help you to uncover potential threats to its financial performance. It could also mean that you avoid buying stocks that have upbeat earnings forecasts, but weak balance sheets, for when the economy's prospects begin to deteriorate.
Sticking within your circle of competence may mean that you miss out on golden opportunities elsewhere. However, it is likely to mean that you are better able to manage your portfolio efficiently across a range of economic and stock market conditions. As Buffett once said, "Never invest in a business you cannot understand."
Being fully invested
The stock market's recent rise may cause some investors to fear missing out on future gains. This may lead them to invest all of their capital in stocks, rather than having some spare cash within their portfolio in case more attractive buying opportunities come along.
In my view, being fully invested in stocks after the S&P 500's 50% rise since its three-year low in March may not be a prudent strategy. Even though cash provides a very disappointing long-term return due to low interest rates, it can provide you with the financial means to take advantage of lower stock prices in the future.
When discussing why he holds a large amount of cash, Buffett once said: "We never want to count on the kindness of strangers in order to meet tomorrow's obligations. When forced to choose, I will not trade even a night's sleep for the chance of extra profits."
Disclosure: The author has no position in any stocks mentioned.
Read more here:
- Walter Schloss on Taking Advantage of Value Investing Opportunities
- Peter Lynch: 3 Investment Principles to Live By
- Why Charlie Munger's Tips Can Help You Outperform
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