The new year is only two weeks away, and the S&P 500 is up 17% so far in 2025. This will be the third year in a row with double-digit gains for the index, making for an 83% gain over the past three years, a fantastic result. It's no wonder so many investors make an S&P 500 index fund a core element of their portfolios.
Warren Buffett would be the first to tell you that's a great strategy. In fact, he has said that most investors should employ this strategy. However, Buffett and his team sold their S&P 500 exchange-traded funds (ETF) last year, and they've been net sellers of stocks for the past 12 quarters, an unprecedented streak.
Berkshire Hathaway's (BRK.A 0.33%)(BRK.B 0.36%) cash pile sits at nearly $392 billion, a 200% increase over the past three years, and its highest ever.
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However, I don't think investors should interpret this as a loss of confidence in the market. Buffett is a big believer in the American story and the power of the market to generate shareholder wealth over time. And although he's sold more stocks than he's bought recently, he's still buying.
So how should investors interpret it? It's not hard to see that the market is expensive today, and after three years of high growth, it's looking more and more like there may be a stock market bubble. Buffett clearly doesn't see many opportunities in today's market, and that could be a setup for some kind of correction.
Investors can't know if that's imminent or still years away, but you can set yourself up for success, no matter what happens in 2026. Here's how.
1. Focus on valuation and avoid expensive stocks.
Buffett is known as a value investor, which means that he seeks undervalued stocks that should be expected to rise to their intrinsic value. As the market becomes more expensive, it's harder to find these kinds of stocks, which is why Berkshire Hathaway's stock purchases have been limited over the past two years. The S&P 500 cyclically adjusted P/E (CAPE) ratio is higher than 39, the highest it's been in 25 years.
In general, Buffett prefers high-quality companies to cheap stocks. One of his most oft-quoted quips is that "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price." This implies that Buffett doesn't see today's prices as fair, let alone cheap.
It's always important to be choosy about valuation and not overpay for a stock; inflated stocks inevitably lead to a drop. But in this environment, it's crucial.
2. Have some cash ready for deals
Buffett won't claim to know if there's a crash coming in 2026, but elevated valuations sure makes it seem likely that there could be downward pressure soon. If you don't have any cash available, you'll miss the chance to buy stocks on the dip if they fall.
Even in the case that the market continues to climb this year, it becomes all the more important to have cash ready to scoop up the few opportunities that do land. For example, Berkshire Hathaway took a position in healthcare giant United Healthcare in the second quarter likely after it plunged and fell to a P/E ratio of 11. Similarly, it took a position in Alphabet in the third quarter, when its average P/E ratio was 22. Today, it's 31.
3. Keep investing
One Buffett tenet is to stay in the market under pretty much all circumstances. The moment you pull your money out, you cement your losses instead of giving your stocks the chance to rebound. And if you're not buying new stocks, you're missing out on market growth and magic of compounding.
"Certainly in the next 20 years, you'll see a period that will be what somebody in the market described one time as a hair curl compared to anything you've seen before," Buffett said at this year's annual meeting. "The more sophisticated the system gets, the more the surprises can be out of right field. That's just...part of the stock market."
Market volatility is a part of the process. Don't panic sell if things get rough, and keep seeking out opportunities.
