Warren Buffett: 5 Rules For Investing In Stock Market Crashes

Things can go on a long time that don't make sense, but they do come to an end. I mean, the internet thing. I mean, you had these companies selling for many billions of dollars that had no, really frankly, no prospects of making any money. That's a bubble. But Herb Stein one time said, "Anything that can't go on forever will end." Now, that's incredible. From what we've seen so far, the bull run of the past 10 years is ending.

The man that we just saw is, of course, Warren Buffett, the best investor the world has ever seen. Over the years, through all the market ups and downs, his company, Berkshire Hathaway, has produced a total return of over 3.6 million percent through their regime of acquisitions and stock investments. A big part of that success is Buffett's exceptional ability to invest during market crashes. Since he took over Berkshire Hathaway in 1965, the S&P 500 has seen 12 negative years, and in 10 of those 12 years, Berkshire was still able to beat the S&P.

And now in 2022, which so far is another negative year, at the age of 91, Buffett is still making big moves. Year to date, the S&P 500 has lost 22%, and in Q1 alone, Buffett sunk 40 billion dollars into the market. So in this video, let's zoom in on five Warren Buffett rules you can implement to help you invest well during this market downturn.

The absolute first thing you must remember is to avoid panic selling a good business. Some people should not own stocks at all because they just get too upset with price fluctuations. If you're going to do dumb things because your stock goes down, you shouldn't own a stock at all. What are dumb things? Selling a stock, yeah, because it goes down. I mean, if you buy your house at twenty thousand dollars, and somebody comes along next time and says, "I'll pay you 15," you don't sell it because the quote's 15. You look at the house or whatever it may be.

Some people are not actually emotionally or psychologically fit to own stocks, but I think more of them would be if you get educated on what you're really buying, which is part of a business. The longer you hold stocks, the less risky they become, whereas the longer the maturity of a bond, the more risky it becomes. This all comes back to Ben Graham's idea of Mr. Market, which Buffett actually references in that clip. If you have a very nosy neighbor that every day pokes his head over the fence and makes you an offer on your house, you know one day he offers you eight hundred thousand, then the next day it's 750 thousand, then one day he just comes out feeling very sad and you know feels the property market might collapse and he only offers you, say, 300 thousand. Are you going to sell him your house? No way! You're just going to head back inside and go about your day.

Exact same thing in the stock market. If you own a piece of a great business, why would you want to sell that just because the people around you are willing to give you less for it? It's crazy. Another Buffett quote is, "The stock market is the only place where investors run out of the store during a sale." It's extremely flawed logic. So don't be that guy.

Sell a stock if the fundamentals have changed for sure. If the price downturn is because of a factor that will permanently impair the business's ability to generate cash flow moving forward, and it no longer makes sense to hold the company, then sure, just get rid of it. Fair enough. But if you've done the digging and you know it's a great company, and it's just being sold off like with the rest of the market, it's very silly to sell because the price could go lower. That's Buffett's first lesson.

Then the second lesson is kind of on the complete other end of the spectrum. It's to realize that actually market crashes are huge yet infrequent opportunities, so make sure you take full advantage. The biggest mistakes we've made by far are mistakes of omission and not commission. I mean, it's the things I knew enough to do. They were within my circle of competence, and I was sucking my thumb, and that is really, those are the ones that hurt. I probably cost Berkshire at least five billion dollars, for example, by sucking my thumb 20 years ago, or close to it, when Fannie Mae was having some troubles, and we were going to buy the whole company for practically nothing.

Big opportunities in life have to be seized. We don't do very many things, but when we get the chance to do something that's right and big, we've got to do it. To do it on a small scale is just as big a mistake, almost, as not doing it at all. I mean, you've got to grab them when they come. The big opportunities in life have to be seized. That is a very important quote from Warren Buffett because the thing is, when the market dives and loses 30 plus percent, those events, they happen very infrequently. I mean, sure the market drops by 10% here or there, but to get the big market drop-offs of 30, 40, 50, those events really don't come around all that often. You know our last big one was 2008. I mean, you could argue that 2020 was a big one, but really that just made companies fairly valued. It didn't really make the vast majority of companies cheap. 2008 did make the vast majority of companies cheap, as happened in 2001-2002.

So that's like two big opportunities since the year 2000. That's pretty damn infrequent. Even if you do want to categorize the 2020 crash as a big one, think about this. If you put ten thousand dollars into the market at the highest point around 3,380 today, you'd have eleven thousand fifty-one dollars—a ten point five one percent return. But if you invested your ten thousand at the bottom, today you'd have sixteen thousand two hundred dollars—a sixty-two percent return, and that's in just over two years.

Now, no, you can't pick the top, and you can't pick the bottom, I get that. But it goes to show that if you have a very low stock market staring you right in the face, you should probably take your opportunity. But what do you buy? Well, this is Warren Buffett's suggestion: "I have an old-fashioned belief that I can only should expect to make money in things that I understand." And when I say understand, I don't mean to understand, you know, what the product does or anything like that. I mean understand what the economics of the business are likely to look like 10 years from now or 20 years from now.

I know, in general, what the economics will say Wrigley Chewing Gum will look like 10 years from now. The internet isn't going to change the way people chew gum. It isn't going to change which gum they chew. You know, if you own the chewing gum market in a big way, and you've got Double Mint and Spearmint and Juicy Fruit, those brands will be there 10 years from now. So I can't pinpoint exactly what the numbers are going to look like on Wrigley, but I'm not going to be way off if I try to look forward on something like that. Evaluating that company is within what I call my circle of competence. I understand what they do, I understand the economics of it, I understand the competitive aspects of the business.

This is very important advice because during a market crash, you're going to hear a lot of companies making the news. You know, in 2020 it was the airlines and travel and cruise companies. Right now, the companies in the news are the high-flying tech companies. But you should never invest in a company, regardless of how cheap it's become, if you don't understand it. You could have bought Bear or Lehman in 2008 because it looked incredibly cheap, but that wouldn't have worked out so well for you. So avoid buying individual companies during market crashes just because they're cheap. You have to make sure that you understand them first.

You know, for me, I like social media. I like entertainment businesses like Disney and Netflix. I like electric cars. There's no way I should be looking into an insurance company that's just dropped 80%. I have to sit back and acknowledge that sure, it looks cheap, but I don't understand it. So when I look at the internet businesses or I look at tech messages, I say this is a marvelous thing, and I love to play around on the computer, and I order my books from Amazon and all kinds of things. But I don't know who's going to win. Unless I know who's going to win, I'm not interested in investing. I'll just play around on the computer.

Defining your circle of competence is the most important aspect of investing. It's not how large your circle is. You don't have to be an expert on everything, but knowing where the perimeter of that circle of what you know and what you don't know is, and staying inside of it is all important. Tom Watson, Senior, who started IBM, he said, "I'm no genius, but I'm smart in spots, and I stay around those spots." That is the key. So if I understand a few things and I stick in that arena, I'll do okay. And if I don't understand something, but I get all excited about it because my neighbors are talking about stocks are going up and everything, they start fooling around someplace else, eventually I'll get creamed, and I should.

So make sure you define your circle of competence and stay firmly inside it. As Buffett just said, if you start falling around outside your circle, eventually you get creamed. All right, let's move on to the fourth key rule to follow during a market crash, and we kind of just covered it in that section there. But the next lesson is to avoid sorting your buy list by cheapest. Always sort your watch list by the quality of the business. I've been taught by Ben Graham to buy things on a quantitative basis. Look around for things that are cheap—they made a big impression on me.

So I went around looking for what I call "used cigar butts" of stocks. The cigar butt approach to buying stocks is that you walk down the street and you're looking around for cigarettes, and you find this honestly this terrible looking soggy, ugly looking cigar, one puff left in it, but you pick it up, and you get your one puff, disgusting, you throw it away. But it's free. I mean, it's cheap! And then you look around for another soggy, you know, one puff cigarette. Well, that's what I did for years. It's a mistake. It's so much easier just to buy wonderful businesses.

So now, I would rather buy a wonderful business at a fair price than a fair business at a wonderful price. But in those days, I was buying cheap stocks, and Berkshire was selling below its working capital per share. You got the plants for nothing. You got the machinery for nothing. You got the inventory and receivables at a discount. It was cheap, so I bought it. Twenty years later, I was still running a lousy business, and that money did not compound. You really want to be in a wonderful business because time is the friend of the wonderful business.

You keep compounding, it keeps doing more business, and you keep making more money. Time is the enemy of the lousy business. I could have sold Berkshire, perhaps liquidated it, and made a quick little profit, you know, one puff. But staying with those kinds of businesses is a big mistake. So you might say I learned something out of that mistake, and what I did with Berkshire is I kept buying better businesses. I started insurance businesses, See's Candy, the Buffalo, all kinds of things. I would have been way better doing that with a brand new little entity that I'd set up rather than using Berkshire as the platform.

Now, I've had a lot of fun out of it. I mean, everything in life seems to turn out for the better, so I don't have any complaints about that, but it was a dumb thing to do. This point has really been Warren Buffett's big contribution to the value investing strategy. As the outline there, Ben Graham was really the first man to write extensively about the value investing approach, but his idea was to buy a diversified group of pretty rubbish companies, cigar butts, but they were extremely cheap.

So the stockholder kind of got one last puff, and then you have to sell and move on. Buffett changed all of that when he said, "To hell with cigar butts. I just want to invest in things I can hold for decades that are high quality and will compound internally." Those stocks, because they're good, are never dirt cheap, but Buffett decided he'd stop listing the businesses by how cheap they were, and instead, he would list them by their quality.

He'd never overpay for these businesses, but he would settle if they were at a reasonable price. That is a very important lesson to observe during a market crash because during a market crash, you get thrown a lot of cheap businesses, but a lot of those businesses are cheaper than the rest for a reason. So don't get sucked in by how cheap they are. Focus on whether they have, you know, ample cash, low debt, a strong competitive advantage, great return on invested capital, and great growth, and wait for those companies to be fairly priced.

That leads us to the last, yet arguably the most important, lesson to observe during a market downturn, and that is to always stay focused on the long term. If you take the 20th century, it was an unbelievable century for the United States. If you take the whole hundred years, it went up 180 times. For every thousand dollars became 180 thousand. But 43 and a quarter years, 43 and three-quarters years, were those three big, huge bull markets, and 56 and a quarter years were periods of stagnation—all in an economy that was doing fine.

Fifty-six and a quarter years, net, the Dow was down a couple hundred points during that period. And the other 43 and three-quarters years made up the rest of this move from 66 to 11,000, some on the Dow. So how could it be that you could have a country that was doing better and better and better and better, every generation was living better than the one that preceded it, but you had these huge changes, big gains a few times, long periods of stagnation? Twenty years, I mean, that's a long time to do nothing.

The answer is that investors behave in very human ways, which is they get very excited during bull markets, and they look in the rearview mirror, and they say, "I made money last year, I'm going to make more money this year." So this time I'll borrow, or the neighbor says, "I wasn't in last year when that neighbor was dumber than I." I had made a lot of money, so I'm going to go in this year. So they're always looking to the mirror, and when they look in the rearview mirror and they see a lot of money having been made in the last few years, they plow in, and they just push and push and push on prices.

When they look in the rearview mirror and they see no money having been made, they just say, "This is a lousy place to be." So they don't care what's going on in the underlying business, and it's astounding. But that makes for a huge opportunity, just a huge opportunity. You know, you will see things you won't believe in your lifetime in securities markets. The country will do very well over time, but you will see these huge waves, and if you can stay objective throughout that, if you can detach yourself temperamentally from the crowd, you get very rich, and you won't have to be very bright.

I mean, I'm sure you are, but you want—you know, it just doesn't take brains; it takes temperament. He's right. It doesn't take brains; it takes temperament. And during market crashes, you know, the herd logic and reasoning really does get thrown out the window. Everybody starts panicking, and it sets off a bit of a death spiral. The more people that try and get out at the same time, the faster the market drops.

So you have to be that person that isn't worried about next week or next month, but knows that the money that they do put into the market is going to be there for the next 10 years. If you can really commit to that, then investing during market crashes becomes a lot easier. Just stay focused on the long term.

Anyway, guys, that's it—Buffett's five rules to navigating harsh market downturn: summary: never panic sell because of the price, take your opportunities when they're given to you, understand what you're buying, buy good companies and not just the cheap ones, and then, last but not least, eyes on the horizon; stay focused on the long term. I hope you enjoyed the video. If you did, please leave a like, subscribe, I'd really appreciate it; helps out the channel a lot. But that'll do us for today. Thanks for watching. See you guys next time.

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