I've been successful as an investor over the past 15 years, managing to build up a sizable portfolio along the way. And while a significant amount of my success is a product of fortunate timing -- a decade-long bull market is an incredibly powerful wealth-generator -- I've also outperformed the market over the long term by focusing on buying great businesses and holding them. Trading stocks doesn't build wealth; owning great companies for very long periods of time is the trick.
That truth is very hard to remember when it feels like the world is going crazy. We have experienced more days of extreme volatility in stocks in the past few weeks than we have in the past few years. Any one of no less than five trading days over the past 10 would qualify as either the worst or best day for stocks in several years, and we very well could break the record for the fastest double-digit drop by the S&P 500 in history this week.
The prior record was reached less than two weeks ago. Even the most steady of hands may be feeling their resolve tested right now.
With many years of investing success behind me, including the good fortune of having already invested across the worst market decline since the Great Depression and multiple double-digit declines, I am sticking to my plan that's proven time and again to deliver market-beating results.
Know your goals, and have a plan based on those
It's "make money," right? Followed closely by "buy low, sell high!" Yes, sure, that is the overarching aim for everyone who invests in stocks. However, the answer here is a bit more nuanced, because it's important to understand the individual reasons behind your investing: Are you saving for retirement? A child's education? Buying that dream vacation home?
Chances are, it's probably more than one thing, and each of those things is bound by a different time frame. It's that time frame that should have the biggest role in determining your plan to reach that goal.
That's because time is both the best friend and worst enemy of the stock investor. The more of it you have, the more you can use these periods of volatility to improve your gains. However, those same volatile periods can destroy your wealth too quickly to recover if you are only a few years away from needing to start using your gains from the stock market to pay for necessities.
My plan is pretty simple: My goals are all based on things that won't happen for decades to come. My kid is three, so there's more than a decade before we would need to start tapping his college savings account; I'm 43, so my retirement savings have 20 years to keep growing; the dividend stocks I'm buying instead of paying down my mortgage will stay invested for 10 or 20 more years as well.
In the short term, I'm not selling any of the stocks that make up almost all of my portfolio. To the contrary -- this is exactly when I'm starting to look for opportunities to buy, to deploy the cash I've been building up in my accounts to take advantage of a market sell-off such as this one. It's part of my broader plan to make sure I'm prepared for a recession.
Looking at the bigger picture, if I were a little older, or if my son were only a few years away from college (or vocational school), then I wouldn't have all my equity invested in stocks, specifically any capital I would be relying on in the next few years to pay for education, groceries in retirement, or some other necessary expense. Simply put, the short-term upside in stocks is not worth the downside in losses. So, part of your plan must include proper asset allocation based on your goals and timeline.
For me, that means being almost entirely invested in stocks right now. If you have money you can't afford to lose in the next few years in stocks, it's past time to start shifting some of your wealth into bonds and cash. Even at lower yields, at least you won't see 10% or more of the money you'll need to make ends meet next year evaporate.
Hold great businesses for the long term, and act opportunistically to buy more
This is the simple secret to putting big market sell-offs to work for you. It's impossible to get out at the "top" to avoid losses, but by holding onto the best companies when the market is panicking, you won't cause harm to your portfolio by selling a great business at the worst possible time: just after (and because) the stock has dropped.
A better approach is to put together a list of high-quality stocks that have fallen sharply during the sell-off while their underlying businesses remain strong. Panic-selling like we are seeing now almost always creates excellent opportunities to buy. For instance, Brookfield Infrastructure Partners (BIP 3.19%) and its parent Brookfield Asset Management (BAM -0.49%) have seen their shares fall 19% and 15%, respectively, in about a month, yet neither company is at serious direct risk from coronavirus or a potential recession.
To the contrary, the underlying assets and businesses they own are relatively immune to economic downturns, generating substantial returns across the economic cycle. Moreover, both have strong records of acting aggressively during market uncertainty to find bargain-bin investment opportunities, growing cash flows that have afforded them the ability to increased their dividends by triple and double, respectively, over the past decade.
Not only does that make them the kinds of stocks to buy when the market is crashing, but it's also evidence of the kind of mindset that's proven to work. It has certainly played a big role in my investing success, and it could do the same for you.