The iconic billionaire investor Warren Buffett once used the idea of shopping for hamburger meat — the most ordinary of daily expenditures — to explain how to buy stocks.
In 1997, Buffett wrote this in his annual letter to shareholders:
A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.
But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period?
Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying.
In short, we get it backwards about the stock market all the time. Yes, we want stock prices to go up. But we also want to manage to buy them when prices are low.
You can’t do both, unless you take the long view that stock prices are going to rise steadily well into the foreseeable future.
Which happens to be true. Stocks in general do rise in value, far more so than other investments over the long haul. It’s how we react in the short term, when stocks can slip, that determines how we do as investors.
If we manage to experience a recession in the coming months — by no means guaranteed but always possible — there are a few things you can do to prepare yourself.
Be a steady buyer: First and foremost, if you’re buying though a fixed investment plan such as a 401(k) or automatic IRA contributions, continue to do so. If a recession hits and stocks fall your contributions become more valuable, not less.
That’s because you will get more shares with the same dollars. You don’t need to increase your investment budget, just leave it be and let your plan do its thing automatically.
Avoid selling in a panic: Part of the problem of a recession is that some stocks will fall more than others. After years of rising along with the market, any given stock could be exposed as a money-loser and see an exodus of investors in short order.
The solution is diversification. By owning hundreds and even thousands of stocks in a single, low-cost index fund or exchange-traded fund, a bad headline about one company or another will not trigger you into selling out at the bottom.
Have cash on hand: A lot of anxiety can be negated simply by having a few months’ living expenses in the bank. If you hate holding cash at a low savings rate keep it in a high-yield checking account or money market fund instead. You might not need it, but you’ll feel better just having cash within reach.
Avoid unsecured debt: Debts that seemed manageable during good times will mess with your financial confidence in a stormy patch. Pay down credit cards and home equity lines while you can. You’ll feel less stressed about investing and about everything else, too.
Recessions happen. They don’t last years, usually months, and most are forgotten easily enough once they pass us by.
Having the financial acumen to think ahead can make a huge difference in your investment picture, not to mention day-to-day stress levels.
MarketRiders, Inc. is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.