There's certainly no shortage of ways to play offense with your retirement nest egg. Indeed, there's always an overwhelming number of investment options that promise to make you rich...if you get into a trade soon enough. That's just the nature of the business.
Smart investors like Warren Buffett know, however, that playing defense can be just as important (if not more important) than finding big winners at the right time. The Oracle of Omaha has even explained in very simple terms how you can protect your portfolio from unnecessary downside. Here's a closer look at what he said, and what it means for you.
Don't be afraid to pay up for quality
He's the brains behind several how-to-invest books, and his live interviews are a reliable source of quote-worthy tips. Yet Warren Buffett's best nuggets of investing wisdom are largely found in his annual letter to Berkshire Hathaway shareholders.
Two of these closely related tips stand out among the rest to retirement-minded folks. In 1989's letter, Buffett penned "it's far better to buy a wonderful company at a fair price than a fair company at a wonderful price." Then, in 2008's letter, Buffett quoted Benjamin Graham's observation that "price is what you pay; value is what you get." The two ideas are actually saying the same thing, though -- you should be willing to pay up for quality.
Don't misread the message. A portfolio of high-quality companies isn't immune to marketwide pullbacks. On any given trading day, three out of four stocks are moving in the same direction as the broad market; the market's tide is that strong. Shares of quality companies tend to hold up better during prolonged periods of marketwide weakness, however, and they tend to bounce back better than their more speculative counterparts.
This admittedly hasn't been the case of late. Quality stocks (stocks of companies with consistent earnings, minimal debt, and a reliably strong return on equity) trailed growth stocks in red-hot 2020, according to data compiled by Guardian Capital, extending a trend started all the way back in 2008. That's when interest rates were moving toward what would be multiyear stretch of low borrowing costs...a condition that firmly favors growth equities. Quality stocks then underperformed value stocks during 2022's bear market, by virtue of losing more ground.
That lagging performance is an exception to the norm rather than the norm, however, rooted in very unusual circumstances.
It's also a somewhat domestic phenomenon. Recent number-crunching done by investing research outfit IQ-EQ indicates that since 2000, the MSCI World Quality Index has outperformed the MSCI World Growth and MSCI World Value indexes. Notably, IQ-EQ's research suggests the quality-oriented index is the only one of the three to boast benchmark-beating gains for the past five-, 10-, 15-, and 20-year time frames; it's essentially tied with the growth index for the past three years.
Data source: Thomson Reuters. Chart by author.
Guardian Capital's data goes on to explain that while quality stocks have only captured about 95% of the overall market's upside since 1982 versus growth stocks' market-beating 103%, high-quality stocks only suffered about 79% of the broad market's total pullbacks. The world's growth stocks led the charges lower, outpacing overall market losses by even more than it led its rallies. Just as notable is the fact that these quality stocks held up better in inflationary periods like the one we're in now, are less volatile, and continue to report the highest profit margins despite the challenging environment.
And bear in mind that the MSCI Quality Index holds stocks based on a variety of factors, none of which are valuation, or a price-based comparison to that company's underlying earnings. In many cases these stocks even seem relatively expensive. Its current top holdings are Microsoft, Apple, and Nvidia, none of which are priced at less than 20 times their trailing-12-month earnings. In fact, the entire index's average P/E ratio right now is just above 20.
Take the hint
Great, but what's this got to do with Warren Buffett, or safeguarding your retirement savings? More than you might realize on the surface.
Picking and buying stocks is a fairly simple task; anyone can do it. Being able to stick with stocks is the tough part. See, investors -- and novice investors in particular -- can have a tendency to lose sight of the long-term picture when distracted by short-term volatility. Big mistake. This short-term noise can prompt you to bail out of a trade at the exact wrong time. Or, perhaps worse, the mindset that allows investors to get distracted by near-term noise in the first place often leads too much trading activity. That's a recipe for poor performance in and of itself.
The solution? Stick with stocks you can confidently continue to own for the long haul even when things turn ugly. Focusing on the value you're getting rather than the price you're paying allows you to comfortably do this. Other, low-quality holdings carry the risk of forcing you to cut steep losses before they get any bigger.
In other words, the premium you pay for quality stocks eventually pays for itself.
