To most people who have invested in the stock market, a market crash like the one in 2008 is a nightmare they would love to forget. What if instead of thinking of stock market crashes like getting a tooth pulled, you thought of them as Christmas morning. This is how the best investors in the world think when it comes to markets crashing, investors like Warren Buffett, Charlie Munger, and Joel Greenblatt, and it’s how we should think too. Here’s how we can…

What if instead of thinking of stock market crashes like getting a tooth pulled, you thought of them like Christmas morning…

Think about it like this, if you were going to buy a rental property or a farm, and you knew how much rent the rental property would put in your pocket, or how much that farm would produce, would you want the price to go up? Or down? I think for most people, for these assets, the answer is obvious, but it’s somehow not so obvious when it comes to stocks. But remember, stocks are tiny slices of real businesses, businesses you probably use on a daily or weekly basis, like Apple, Starbucks and Costco. And if we’re planning on buying stocks that produce cash for us, like the rental property or farm, for the foreseeable future, we want the price to go down, not up. Because we want to pay less for that cash those businesses produce, not more. When we pay more, it lowers our returns, and compounding is greatly dampened.

When we pay more, it lowers our returns, and compounding is greatly dampened…

Remember, stocks are different in the way that we don’t see cash deposited into our bank account from the profits we’re entitled to. Instead, as the owners of those shares, we usually see the bulk of profits returned to us in the form of capital gains, but they can also be distributed through dividends. Successful investing takes great patience. Charlie Munger, Warren Buffett’s partner, says “The big money isn’t in the buying or the selling..it’s in the waiting.” I interpret this as the waiting in being patient for markets to go down, patience to buy only companies you understand, and patience to let the businesses work. Just like a rental property, you wouldn’t expect the value to go up 100% next week, you know that if you purchased it at a good price, you’ll be making a good return right away with the rent, and then slowly over time, you can increase the rent to increase your return. The same goes for stocks. We want compounding to work its wonders. We want to own businesses we can own forever, just like a good rental property or farm.

 

It’s completely counterintuitive, I know. But this is how all the great investors have done it. If you look at Warren Buffett’s track record over time, you’ll see he really only had a handful of decisions that made his investment record of 25% returns over almost 7 decades what it is. Investments like Coca-Cola, American Express, and Gillette to name a few. And it’s been the same for me, it’s really only been 3 or 4 stock picks so far, that have made my returns what they are.

 

So for us small fishes, if all we need is a few good stocks, we can afford to be patient and wait for our fat pitches. We definitely don’t need to swing at everything, just like you wouldn’t buy the first rental property that pops up. Thankfully investing, unlike most things, is a no strikes called game. We can wait, and wait, and wait, and let lots of mediocre opportunities pass us by, and then swing on those few great pitches that come across the plate. Investing in this way allows us to protect ourselves from big losses, because remember, just like how you’re patient to buy that rental property only when it’s on sale and a really good deal, the same principle applies to stocks. If we bought that stock when it was on a crazy ‘Black Friday’ type sale, we know that even if things don’t go as planned, we’ll end up okay because we bought it at such a good deal. Just like that rental property you bought; if it ended up not working out, you could always sell it for a decent price and recoup what you bought it for.

It’s actually an incredibly exciting time right now. Almost like a lull before a big storm…

Right now, if you look through the different lenses investors like Warren Buffett use, like this one called the Shiller PE ratio, or the Wilshire GDP ratio, the stock market is as overvalued as it was in 1928-29. Now this doesn’t mean you still can’t find bargains, but it just makes it a bit more challenging to find them. It’s kind of like a supermarket on a Sunday night, it’s been pretty picked over. So what this means for us, and great investors like Warren Buffett, we have to wait, and hold cash or short term equivalents that we can easily get our hands on if opportunities pop up. It’s actually an incredibly exciting time right now. Almost like a lull before a big storm. But patience is everything here, if we can’t wait for that fat pitch, we’re going to perform like everyone else, and all our effort will be for naught.

So the first thing we need to do to prepare for a stock market crash, is we have to have a game plan ready. We need to have a watchlist full of wonderful businesses we love and understand, run by great trustworthy people. We need to know what we would be willing to pay for those businesses, and be ready to pull the trigger. Remember, you don’t need many good investments to do extremely well over time. A handful is all it took for Warren Buffett over 70 years.

we have to have a game plan ready…

Second, have your cash ready to go. Just like Warren Buffett, who’s sitting on 100+ billion dollars, waiting for those fat pitches. I call this our war chest, it’s what we’re going to use to crush the market and mutual funds over time. If we can be patient, consistent 15-25%+ returns are most definitely in the realm of possibility.

 

Third. Turn off the noise and think. In a storm it’s never pretty. There is a lot of screaming and yelling, usually everyone’s soaked and miserable and scared. But you have to be able to get off by yourself and see the storm for what it is, a great opportunity, and it will pass. It’s completely counterintuitive I know, but if you’ve planned for the worst, prepared your shopping list and have your war chest ready to go, you are going to absolutely crush those fat pitches when they come at you.

In a storm it’s never pretty. There is a lot of screaming and yelling, usually everyone’s soaked and miserable and scared…

I would also add, if you already own stocks, give them a good once over analysis and see if they’re overpriced. Test yourself to make sure you truly understand what you’re invested in, look at them through the 4 pillars of investing taught by the greatest investors: 1. Do you understand it? 2. What’s the competitive advantage like? 3. How’s management? 4. Is it a good price? Do your investments pass the test? Remember we are looking for ‘so obvious it’s like a punch-in-the-face’ investment opportunities. It should be so obvious that if you have to think about it, it’s probably best to pass on it. The risk in market crashes comes from having paid too much for companies, not understanding what you’re invested in, and not having a war chest ready to go.

 

Being able to weather a storm means being prepared ahead of time, having the right knowledge ready to go, and being ready to act. Remember to be patient, It’s far more painful to not have funds available, and see your favourite company at fire sale prices, and not be able to jump on it.

 

“An ounce of prevention is worth a pound of cure…” – Benjamin Franklin.

 

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