The investing community pays close attention to Warren Buffett. Sometimes you have to look closely or read between the lines to see what he means, and recent events are in that category, but his message is still loud and clear.
As a public company, Berkshire Hathaway (BRK.A 0.07%) (BRK.B -0.01%) provides quarterly updates about its performance. It also files a form 13F, which details quarterly trades.
In the third quarter, Berkshire Hathaway reported holding $325 billion in cash, its highest level ever. It was also a net seller of stocks, a pattern that’s been ongoing for several quarters.
Buffett has generally been transparent about his investing approach, and it’s pretty simple, amounting to buy low and sell high, with some added details. He’s a proponent of the value approach to investing, and he doesn’t buy a stock unless he sees it as a great deal that could provide tremendous value to his organization.
You don’t have to see Buffett’s public filings to understand that the market is looking bloated today. The S&P 500 is up 26% this year and trading at record highs. Stocks are trading at high valuations, and at current levels, they could be due for a correction.
That doesn’t mean it’s going to happen tomorrow; Buffett has been getting ready for a while now. But it will happen. I say that not because I can see into the future, but because that’s the nature of the market. There are bear and bull markets, dips and corrections, and even crashes.
The question no one can answer is when. But it’s important to be prepared when it finally happens. Here are three things every investor should do.
1. Have cash on hand
It’s important for everyone to keep cash ready outside of your investments. First of all, you should keep an emergency fund for a rainy day.
Aside from that, you should have funds available for investment on a consistent basis. The most successful way to invest might be boring, but it’s safe, and it works: Invest consistently and let the magic of compounding do its work. Whether it’s $50 a month or more, each dollar you put in compounds over time and creates gains that are otherwise unachievable.
If the market is starting to look expensive, you might want to be more choosy about your investing and keep more funds available for the inevitable dip.
2. Avoid inflated prices
“What goes up must come down” doesn’t apply to everything; but it applies to unreasonable valuations. I didn’t say high valuations, or even rich valuations, because some premium valuations are warranted. A company growing by leaps and bounds can carry a higher valuation than a mature, slow-growing enterprise.
But when a valuation raises eyebrows, and investors keep piling money in, it’s a signal to step back.
Image source: The Motley Fool.
One of Buffett’s most famous quotes is: “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.” But fewer people know what he said next:
As this is written, little fear is visible in Wall Street. Instead, euphoria prevails — and why not? What could be more exhilarating than to participate in a bull market in which the rewards to owners of businesses become gloriously uncoupled from the plodding performances of the businesses themselves. Unfortunately, however, stocks can’t outperform businesses indefinitely.
You would think investors paid attention to that wisdom, but there have been several sky-high bull markets — and crashes — since then. Buffett is acting on his own advice right now by avoiding stocks whose valuations look like they might be uncoupled from their companies’ performance.
That doesn’t mean you can’t get a good deal today. Berkshire Hathaway took two new positions in the third quarter in Domino’s Pizza and Pool Corporation.
3. Hold on tight
One of the reasons markets crash is because of the disease Buffett calls fear. Investors panic-sell and lose their investments when they get worried, creating a downward spiral. But long-term investors know that dips, corrections, and crashes are part of being in the market.
If, for example, you had sold at the beginning of the previous bear market, you would have missed out on the incredible gains since then: The S&P 500 is up 67% since the beginning of the new bull market. Nvidia, the stock of the moment, is up more than 1,000% since then, even though it lost half of its value in 2022.
It’s more of a mindset than an action, and it’s really simple for investors: Buy stocks you believe in and let time and the market do their magic.
Jennifer Saibil has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway and Domino’s Pizza. The Motley Fool has a disclosure policy.
