Between 2007 and late 2008, the S&P 500 lost nearly 57% of its value over 517 days. While that sounds like a bloodbath, billionaire investor Warren Buffett called it an "ideal period for investors."
Buffett's perspective is more than positive spin -- it's an actionable lesson for investors in bear markets. The context of this comment was Buffett's 2009 letter to the shareholders of Berkshire Hathaway, the conglomerate he runs. In that letter, he had this to say about one of the stock market's worst downturns in history:
We've put a lot of money to work during the chaos of the last two years. It's been an ideal period for investors: A climate of fear is their best friend.
Fear creates opportunity
Fearful investors sell. Wide-scale selling reduces demand and pushes share prices down, which fuels more fear. Buffett likes those cycles because they create opportunities to buy good stocks at a discount.
To be clear, a falling share price isn't always a good thing. Some stocks drop because the company's ability to generate shareholder value changes for the worse. At that point, the stock is worth less than it was before.
But when investor sentiment is largely driving a downturn, good stocks lose value, too. And that's an opportunity for investors to scoop up shares at a discount. It's like buying designer shoes on sale -- the quality is still there, but the price is lower.
Making friends with this bear market
It's been about 13 years since the 2007 bear market bottomed, and stocks are struggling, once again. Since Jan. 3 of this year, the S&P 500 is down about 20%.
Buffett has responded by putting Berkshire Hathaway's money to work. According to the company's 13F filing, Buffett poured tens of billions into stock purchases in the first quarter. Now, in the second quarter, the market has continued its decline. If Buffett sticks with his old habits, he's likely still buying.
If you're ready to deploy Buffett's strategy, make friends with this bear market, and enhance your wealth-building potential, here's how.
- Identify stocks you like. Not all stocks are good candidates for buying in a bear market. Choose companies with strong balance sheets and good track records for managing through downturns. These should be stocks you're comfortable holding for the long haul.
- Know your budget and timeline. Investing in a bear market is not a get-rich-quick scheme. You can't predict how long the bear market will continue or when a recovery will arrive. It could take six months or six years. Confirm you can live without your invested funds for at least five to 10 years.
- Invest in increments. Invest smaller amounts each month vs. one large amount at a time. This way, you can reassess your appetite for investing as economic and market conditions evolve.
Benefits of bear market investing
The basic formula for making money in the stock market is to buy low and sell high. Strategic investing in a bear market addresses the buy-low part of the equation. You can sell high later -- if you need the cash -- after waiting for the market to rebound and return to growth.
Bear market investing can ramp up your long-term wealth potential, but it's not for everyone. You'll need available cash plus the stomach to invest when share prices are falling, as well as the patience to wait for a recovery. With those caveats, the strategy that works for Buffett can work for you, too.