Beating the index is never easy, but one investor who has been able to do it is Warren Buffett. During the course of his investing career, he has outperformed the S&P 500 on a consistent basis.
One of the most interesting aspects of Buffett’s investment strategy is his attitude towards falling stock markets. Unlike many investors, he does not panic when stock prices fall. Rather, he sees it as a buying opportunity. Likewise, during bull markets, he builds up his cash resources in order to profit from the next bear market.
Investors who are able to follow the relatively simple changes which Buffett makes to his asset allocation during the economic cycle could benefit in the long term. With stock markets having fallen in recent months, now could be the perfect time to start.
The ‘Sage of Omaha’ is somewhat famous for saying that investors should ‘be fearful when others are greedy, and greedy when others are fearful’. Although it is not possible to state with certainty that investors are ‘fearful’ at the present time, the uncertainty facing the world economy and the decline in major indices such as the S&P 500 and FTSE 100 in recent months suggests that they may at least be concerned about the prospects for their portfolios.
This, then, could be the start of an opportunity to deploy spare cash into high-quality stocks trading at low prices. Buffett has a history of executing this strategy. In the financial crisis, for example, he made significant profits from apportioning capital to the under-fire financial services industry at a time when many investors were bearish about its prospects. Through focusing on a stock’s fundamentals, it may be possible to obtain bargain investments due to external factors and investor fear.
Of course, preparing for bear markets is another significant part of Buffett’s investment philosophy. While many investors feel confident and optimistic during bull markets, which leads to increased investing, Buffett appears content to allow his portfolio to skew towards cash, rather than stocks, during such periods. In other words, he builds his cash resources in preparation for an opportunity to buy stocks at lower prices in the long run.
Furthermore, Buffett’s favourite holding period is apparently ‘forever’. This, though, does not only apply to stocks within his portfolio. He also appears to be happy to keep his wealth in cash over an extended time period, while many investors would become impatient and decide to invest in the stock market. In doing so, he affords himself the best opportunity to outperform the market over the long term.
While Warren Buffett’s investment strategy may sound simple, putting it into practice is exceptionally challenging. That’s partly because many investors look at the short run, rather than the long term. Instead of considering where a portfolio will be in a couple of years’ time, it may be prudent to think ten years ahead. That way, switching between stocks and cash at the right time of the economic cycle may become an easier process which seems to be an obvious way of beating the stock market.
The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.