You need to keep a cool head in a stock market crash. Otherwise you risk making serious errors that could cost you dearly in the longer run. Few investors have cooler heads the US billionaire Warren Buffett, and this has helped him negotiate crash after crash to build his fortune.
Warren Buffett has seen it all before, and knows how to respond in uncertain times like today. So what do his words of wisdom tells us right now?
1. Avoid panic when stock markets crash
It is easy to do things you regret in a stock market crash. Like selling at the bottom, just before it rebounds. Then buying back into the market at a much higher price.
You have to stay calm when shares are going crazy. As Warren Buffett put it: “Remember that the stock market is a manic depressive.”
It overreacts, both on the ups and the downs. Make sure you don’t. The best thing you can do is sit tight.
2. Choose your targets carefully
In a bull market, bad companies rise alongside the good. They often sink faster in a crash, though, because as Buffett famously said: “Only when the tide goes do you see who’s swimming naked.”
The tide is out today thanks to the pandemic, and it isn’t a pretty sight. It’s at moments like these that hidden deficiencies become exposed. Such as management that have lost control of the balance sheet, or been left behind by more nimble competitors.
So today you might want to avoid, say, companies whose net debt is suddenly several times bigger than their market cap, or have that been outpaced by whizzier online rivals.
By contrast, companies that have maintained dividends throughout the crisis may be doing something right. As are those that have shunned government furlough support, and are hiring rather than firing.
3. Look to the long term
A stock market crash can hurt. At the lowest point on 23 March, your portfolio could have fallen by up to a third. It hurts a lot less, if you think in terms of decades, rather than days or weeks. History shows us the stock market always recovers from a crash, provided you give it enough time.
You need to apply the same long-term attitude when buying stocks. As Warren Buffett said: “Time is the friend of the wonderful business, the enemy of the mediocre.” He also said that: “The stock market is designed to transfer money from the active to the patient.”
So look for wonderful businesses, and be patient with them. Prioritise FTSE 100 companies with a clear pitch to customers and a strong defensive ‘moat’ against competitors. Thanks to the stock market crash, many are trading at reduced prices.
Buy today with the aim of holding for them for years. Or follow Warren Buffett’s mantra. His favourite holding period is “forever”.