Billionaire investor Warren Buffett is used to plunging stock markets. He’s seen many of them in is long career. And in his 2019 letter to Berkshire Hathaway shareholders, he told us how he handles them.
And that’s advice worth listening to. Buffett has compounded his gains by many thousands of percent over the years, despite regular market setbacks.
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Animal spirits
Within Berkshire Hathaway, Buffett invests in listed stocks and by taking ownership of entire businesses. Meanwhile, his annual shareholder letters are available online free of charge for anyone to read, Berkshire shareholder or not.
But perhaps one of the biggest challenges for investors is the way the stock market can stir animal spirits. When stocks shoot higher, those spirits can induce feelings of elation.
And in some cases, that can lead to displays of over-confidence, chest-beating and self-satisfaction – or is that just me?
But those same animal spirits can work against investors when markets and stocks change direction and plunge. Common feelings might be worry, depression and a loss of confidence. And those things can induce displays of weeping and forehead slapping – but again, I’m going on personal experience here!
However, Buffett has always advocated keeping a cool head and maintaining a business-like perspective regarding investments.
In the 2019 letter, he said there will be major drops in the market. And sometimes those moves will be “of 50% magnitude, or even greater”.
But I’d extend that by adding that, it may not be the entire stock market that drops. However, sub-sections of it might, such as small-cap shares, or cyclical stocks. Or maybe stocks in a specific niche within a sector could fall. Or perhaps individual companies facing short-term challenges drop out of favour with the market.
Keeping the faith
And one recent example of that phenomenon is the way the FTSE 100 index maintained its strength during last year’s bear market. Yet under the surface, many stock prices suffered absolute carnage.
Meanwhile, Buffett thinks “The American Tailwind” will always power his investee business over the long haul.
And he believes the strength of the American economy will combine with the way businesses compound their earnings to produce a satisfactory investment outcome for him over time.
So far, he’s been spectacularly correct about that.
He reckons stocks and shares are “the much better long-term choice for the individual who does not use borrowed money and who can control his or her emotions”.
And that’s why we often see him buying quality stocks when they’ve been marked down in price by the market. And why he tends to hold on to those carefully-chosen stocks he already owns.
There can never be a guarantee of positive long-term outcomes from investing in shares. But I have similar faith in other Western economies, such as the UK’s, for example. So, for me, Buffett’s approach to handling market setbacks is equally valid for long-term investors targeting UK investee companies.
