I don’t think many investors would argue with me if I said that right now is one of the most challenging times to be an investor in recent memory.
The world is facing a combination of severe economic headwinds, all of which threaten (or are already) to disrupt the recovery from the Covid-19 pandemic, which was in itself a once-in-a-generation shock.
And against this backdrop, central banks are unwinding a monetary stimulus program that has been in place since the financial crisis.
I am not going to discuss whether or not now is a good time to withdraw monetary stimulus from the market, but I will say that it is having an impact on equity markets. The impact is exacerbated by the fact that investors have rushed into speculative growth names over the past two years, pushing valuations up to record levels.
The combination of economic, fundamental, structural and technical factors are causing significant volatility and uncertainty in equity markets.
I will admit that I have not really been investing long enough to see an environment with so much uncertainty and an environment where central banks are withdrawing liquidity from the system rather than adding it. That’s why I’ve been trying to understand how investors with more experience than myself are reacting.
There’s no investor who has more experience navigating different market environments than Warren Buffett (Trades, Portfolio). And it is the Oracle of Omaha‘s advice that I have been consulting to try and build a roadmap for navigating today’s markets.
A roadmap for the current market
I think there are four main pieces of advice from Buffett that can help any investor navigate to the current environment.
First of all, investors need to keep in mind that investing is a marathon, not a sprint. We should never invest in securities hoping they will go up in value over the next couple of months. Additionally, if you’re not comfortable owning the stock for at least four or five years, you shouldn’t own it at all.
Second, there is never any need to invest. The best investors say no to almost everything. Just because a stock has fallen in value doesn’t necessarily mean it is a good bet. You don’t have to make money back the way you lost it. Sometimes, a bad idea is bad, and there is no shame in selling up and moving on.
Third, companies with strong competitive advantages are usually the best positioned to navigate uncertain economic environments. However, it is not sensible just to buy a company because you think it might have a competitive advantage. We can only really identify if a company has a competitive advantage if we know and understand the sector. So we need to focus on the businesses we understand and not get distracted by other potential opportunities. In a volatile market, it can become easy to get distracted.
Finally, I think some of Buffett's most important advice, especially for the current market, is the fact that most investors are terrible at picking equities. If they want to invest in the stock market, the best solution for most investors is to buy a low-cost index tracker fund. Dollar-cost averaging into an index tracker fund helps remove psychological biases and the prospect of making a mistake by investing in something one does not understand.
I wanted to highlight some of Buffett's more cautious advice in this discussion because I believe caution is the name of the game right now. With so much uncertainty, investors should be seeking to preserve capital over everything else. That means focusing on what you know, ignoring other opportunities if you don’t understand them and, if it all becomes too much, letting a passive fund do the work.
There will be opportunities in this market, but there will be risks as well. Understanding the difference between the two is the key to success.