Stocks have been on a wild ride in April. Days when the S&P 500 (^GSPC +1.02%) moves more than one percentage point in value have become the norm, while the options-based VIX index (a measure of expected volatility) has zoomed higher. It's safe to say many investors are suffering from whiplash as stock prices quickly move up and down.
There's a clear reason for the volatility in the markets: a massive amount of uncertainty. The Trump White House started a sell-off by announcing massive and broad tariffs. It has since walked back much of those tariffs and said it will make carve-outs for specific products.
However, that stance has been off-putting to many of America's largest trade partners, leading to significant backlash. That includes many foreign investors pulling money out of U.S. securities, weakening the dollar. Economists expect inflation to spike, and some fear the U.S. could be heading toward stagflation, with poor growth in gross domestic product (GDP) and jobs.
On top of that, the market just entered an earnings season during which investors will be looking to management teams for any additional information they can get. But with so many variables, many companies are likely to avoid predicting what the future might hold.
So, it's natural to be hesitant to invest amid the economic uncertainty, but times like these could be great for investors. Just ask Warren Buffett, one of all-time greats. He has some timeless advice for how investors should think about volatile markets.
Image source: The Motley Fool.
Profit from folly
While it's true that the short-term economic outlook for the U.S. and the world at large has become increasingly opaque, the resulting market volatility is an opportunity for true long-term investors.
Buffett once said, "Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it."
If investors want to profit from folly and avoid participating in it, they need to be able to identify it when they see it. Buffett gave a great explanation of folly in the market that's possibly more apt today than it was 30 years ago when he wrote it in his letter to shareholders.
We try to price, rather than time, purchases. In our view, it is folly to forgo buying shares in an outstanding business whose long-term future is predictable, because of short-term worries about an economy or a stock market that we know to be unpredictable. Why scrap an informed decision because of an uninformed guess?
As short-term uncertainty has climbed higher and higher in recent months, it's important for investors to focus on the long-term health of the companies whose stocks they own. Unless their prospects have materially changed in the last few months, they're very likely trading at a much better value today than they did in February when stocks were at all-time highs.
Two Buffett strategies to use amid volatility
Buffett's investing style involves buying stocks in great long-term businesses when they trade below their intrinsic value. The amount the stock trades below its intrinsic value is called the margin of safety.
Buffett insists on a margin of safety on every stock purchase, but the amount of that margin will differ based on how easily he can forecast the business's financials. A steady utility stock, for example, might need only a small margin, while an international tech stock driven by innovation might need a much wider margin of safety.
Maintaining an appropriate margin of safety on every investment decision will provide the confidence you need to hold your stocks through market volatility.
Another confidence booster is to focus on companies within your circle of competence. Your circle of competence is the area(s) where you have a level of expertise that gives you an advantage over the average person. For example, you might be an expert in trading cards, allowing you to easily identify great deals at garage sales from parents just trying to off-load their kids' "junk."
If you apply the same idea to businesses, you can be successful in the stock market. Buffett said that accurately defining your circle of competence is the most important thing in business and investing.
Putting it all together: When the stock market fluctuates wildly, it's an opportunity to capitalize on others' short-term thinking in favor of long-term thinking. If you invest within your circle of competence and employ a suitable margin of safety, you can do well in the long run. That core strategy is how Buffett has practically doubled the performance of the S&P 500 over a period of 60-plus years.
