Could the stock market plunge by 50%? Here’s what Warren Buffett would do

Here’s Warren Buffett’s advice on how to handle a 50% decline in the stock market.

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I’ve been seeing more ‘red’ days than ‘blue’ days in my portfolio of late. So I’m tuning in to billionaire investor Warren Buffett’s advice for guidance.

A changing geopolitical landscape

Sadly, the troubles in Ukraine and tensions in wider Eastern Europe have the potential to change the geopolitical landscape for a generation or more.

But could the current bear run extend to major big-caps and other stocks retracing by as much as 50% or more? Maybe. But Buffett said years ago: “Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market.”

And he revisited the theme in his 2019 letter to the shareholders of his conglomerate and stock-holding vehicle Berkshire Hathaway. The letter was published early in 2020 — immediately before the huge plunge in stock prices that year caused by the arrival of the coronavirus pandemic. Perhaps he saw that one coming. But he’s been saying the same thing for decades regardless.

The main thrust of his advice is that investors with a 10- to 20-year investment horizon “will fare well in stocks.” But that’s only if we focus on the earning power of companies. He reckons well-chosen stocks will likely “always” do better than assets such as bonds over the long haul.

But the caveat to that prediction is “anything can happen to stock prices tomorrow.” And, occasionally, there will be major drops in the market, “perhaps of 50% magnitude or even greater.” 

Warren Buffett’s faith in compounding

How can Buffett be so sure that stocks backed by quality and growing businesses will deliver a positive investment outcome despite declines of as much as 50% along the way? I think the answer to that question is in the way growing businesses compound their own earnings.

Buffett tends to buy stocks and hold them while the businesses behind them do the heavy lifting to power his portfolio. And if a business reinvests its growing stream of earnings to produce even more growth, the progress will likely show up in a rising share price in the end.

Back in 2020, when Covid-19 hit the markets and caused stocks to plunge, Buffett said the pandemic had not changed his long-term outlook. And his advice at the time was: “I don’t think it should affect what you do in stocks.” 

So I reckon the current situation is similar. Even war in Eastern Europe will pass. And stock markets will probably recover.

In 2020 as the markets plunged, Buffett said he was more inclined to buy stocks than he was previously. And the main reason for that stance was that valuations had become fairer for many great businesses. Meanwhile, we have a similar situation today. Indeed, not all businesses will be irreparably damaged by the situation in Eastern Europe. Some may not be affected much at all.

So I’m working hard on my watchlist, tuning into the markets and doing my own research. And the goal for me is to buy stocks at opportune moments when the valuation makes sense of a long-term investment in good and growing businesses.

RISK WARNING: should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice. The Motley Fool believes in building wealth through long-term investing and so we do not promote or encourage high-risk activities including day trading, CFDs, spread betting, cryptocurrencies, and forex. Where we promote an affiliate partner’s brokerage products, these are focused on the trading of readily releasable securities.

Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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