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Investing in a Crisis

July 16, 2020

WHAT WOULD WARREN BUFFET DO?

The answer to this title question may surprise those not as familiar with Warren Buffett’s investment style. But it does not surprise Robert Johnson, PhD, CFA, CAIA, professor of finance at Creighton University’s Heider College of Business. Johnson discusses the Oracle of Omaha’s investment strategy in good times and bad, focusing directly on the current COVID-19 economy and its effects on the stock market.

“Investing in a Crisis: What Would Warren Buffett Do?” is the seventh installment of the Business Bites Webinar Series, a collaboration between the Heider College of Business and the Greater Omaha Chamber.

STOCK MARKET VOLATILITY

“Anything can happen to stock prices tomorrow. Occasionally, there will be major drops in the market, perhaps of 50% magnitude or even greater.” -Warren Buffett

It is not a matter of IF the market will take a nosedive but when. So, it is important to determine your risk tolerance to help you weather this volatility. Risk tolerance is a function of both your ability and willingness to bear risk. Consider objective factors, like years to retirement or how far away you will need tuition money from a college fund, to establish whether you want an aggressive or conservative approach. Also consider subjective factors, or personal characteristics, like your ability to cope with stress. Do large swings in the market make for sleepless nights? Maybe a conservative approach is best for your peace of mind.

WHAT TO DO DURING VOLATILE MARKETS

“Re-watch your favorite Super Bowl commercial, get ice cream with your kids, say hi to a friend you haven’t spoken with in a while.” – Warren Buffett

In other words, don’t do a thing. Take the long game view of wealth accumulation and know that whatever market volatility you are experiencing, like the wild fluctuations the pandemic has born, will pass.

INVESTING IN BEAR MARKETS

“Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.” – Warren Buffett

This is the crux of the value investing strategy – finding solid companies whose stock prices are undervalued, purchasing shares, and then holding on to those shares as the company’s stock rises in value.

Buffett has also said “Be greedy when others are fearful and fearful when others are greedy.” Buy when stocks are low. It is difficult to do, but the reward will be great, he maintains. It is all part of a long-term time horizon.

TIME HORIZON

“Sentiment drives the market in the short run while fundamentals drive the market in the long run. If you don’t feel comfortable owning a stock for 10 years, you shouldn’t own it for 10 minutes.” - Warren Buffett

Don’t watch the talking heads on cable news channels who tend to reinforce jumping from one “hot” stock to another, Johnson advises.

Do buy quality companies with solid balance sheets and hold them for a long time. It is what Charlie Munger, vice chairman of Berkshire Hathaway calls “sit on ass investing.”

Or, as Johnson paraphrases for these pandemic times, “Don’t touch your face and don’t touch your 401k.”

IMPORTANCE OF INTEREST RATES

“Interest rates act as the gravity for stock prices. When rates are high, stock prices should be lower. When rates are low, stock prices should be higher. After all, everything is relative in finance. Whether an investment is ‘good’ or ‘bad’ depends on the alternatives available at any given time.” – Warren Buffett

While it is true that the pandemic has resulted in stock market volatility, the market is nonetheless advancing, even in an uncertain economic climate. This is in large part due to interest rates, which currently are extremely low, says Johnson.

KEEP INVESTING SIMPLE

“Consistently buy an S&P 500 low-cost index fund. I think it’s the thing that makes the most sense practically all of the time.” – Warren Buffett

For his wife’s estate, Buffett has recommended the Trustee maintain a portfolio that is 90% invested in an S&P 500 index fund and 10% in short-term Treasury bills.

POLITICS AND MARKETS

“Our country’s almost unbelievable prosperity has been gained in a bipartisan manner. Since 1942, we've had seven republican presidents and seven democrats. In the years they've served, the country contended at various times with a long period of viral inflation, a 21% prime rate, several controversial and costly wars, the resignation of a president, a pervasive collapse of home values, a paralyzing financial panic and a host of other problems. All engendered scary headlines; all are now history.” – Warren Buffett

The havoc Covid-19 has wreaked on the economy has been devastating. But we’ve faced devastation before. Johnson cites 1987 as an example. During that year, the market crashed 22% in a single day but nevertheless the year produced an overall return of plus-5%.

Johnson calls the ability to ride out economic storms Rip Van Winkle investing: invest, fall asleep, wake up, and everything is just fine.

Investing Financial

INNOVATION

“Investors in innovation end up disappointed.” – Warren Buffett

Why? Because very often they don’t pick the right horse to ride, says Johnson, and end up over paying for innovation. Staying with the staid, investing in the tried and true, provides tremendous returns. It is why Buffett puts his money in such businesses as Dairy Queen and the Nebraska Furniture Mart.

GOLD

“The world's gold stock is about 170,000 metric tons, which if melded together could create a cube of about 68 feet per side. The cube would be worth $9.6 trillion. For that much money one could buy all the cropland in the United States, purchase 16 Exxon Mobils and have about a trillion dollars-worth of walking money walking around money left over.” -Warren Buffett

Gold does not have impressive returns in the long run, says Johnson. It does not provide for cash flow, and it’s worth is relative in that it is based on what someone else thinks its value is. Further, it is subject to what Johnson calls “the greater fool theory” – you need to find a greater fool to buy it from you.

Says Johnson: “Investing in gold is pure speculation.”

LEVERAGE

“My partner Charlie [Munger] says there are only three ways a smart person can go broke: liquor, ladies and leverage. Now the truth is – the first two he just added because they start with L – it’s leverage.” – Warren Buffett

Leveraging is borrowing money to invest, and it magnifies returns both positive and negative. Johnson offers leveraged exchange traded funds (ETF) as an example. Those funds promise to magnify the returns on the S&P by two or three times. But the potential to experience equally dramatic losses are very real, too.

HOW TO SAVE

“If you want to make saving a priority, take a look at how you budget. Do not save what is left after spending; instead, spend what is left after saving.” – Warren Buffett

It is not popular, especially with all the shiny new things constantly being released to great hype and the easy credit to acquire them, but resist the urge to live beyond your means. Establish a budget in which your necessities are covered. Designate a savings target and then spend only what is left over.

INVEST IN WHAT YOU KNOW

“One of the things we try very hard to do at Berkshire is to stay within what I call our circle of competence.” – Warren Buffett

Berkshire’s “circle of competence” did not include tech in the 1990s or mortgage-back securities in 2008 and 2009. So, Buffett did not invest in those securities. No one can know every sector well enough to invest confidently. You may miss out on a few good runs, like the dot.com boom, but you will be shielded from great losses, like the dot.com bust or the crisis following the housing market crash 12 years ago. Besides, if Warren Buffett can admit he doesn’t know everything, you certainly can.

The path to accumulating wealth, even during a crisis, is slow and steady investing. Max out your 401k; buy solid, if not undervalued, companies’ stock and hold on to them; accept that market volatility is expected so don’t sweat the wild swings and keep your eye on the horizon. And while you are at it, Johnson says, invest in something other than stocks – yourself.

“The key to career success and individual happiness is to never stop learning,” he says. “Invest in your own human capital."

This content was developed as part of our Business Bites series, a virtual education opportunity sponsored by the Heider College of Business in partnership with the Greater Omaha Chamber. Request the full interactive Business Bites session to learn more.

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Robert R. Johnson, PhD, CFA, CAIA, is a Professor of Finance at Creighton University's Heider College of Business. He is also Chair and CEO of Economic Index Associates. Until April 2018, he was President and CEO at The American College of Financial Services in Bryn Mawr, PA. He was formerly Deputy CEO at CFA Institute in Charlottesville, VA and was responsible for all aspects of the CFA Program for the majority of his 15-year tenure. He has over 80 refereed articles in leading finance and investment journals.