The threat of a second stock market crash may leave some investors uncertain about the management of their portfolios. For example, they may think that buying stocks is a risky decision. However, other assets such as cash and bonds offer disappointing returns in many cases.
Therefore, taking Warren Buffett’s advice might be a good move. His long history of outperforming the stock market and his ability to use short-term challenges to his advantage could serve as a useful guide during a time of uncertainty for the global economy.
Hold cash before a stock market crash
Predicting when the next stock market crash will occur is extremely difficult. As the market decline this year has shown, a downturn can take place at any time without warning. However, the existence of risks such as Brexit and the coronavirus pandemic means investor sentiment can be very variable at the moment. As such, there could be an increased likelihood of a second global stock market downturn in the coming months.
Therefore, following Warren Buffett’s lead and holding cash might be a logical approach. It still has a significant amount of cash if the stock market falls to more attractive buying levels. This has allowed him to buy undervalued stocks when other investors sell them, improving his chances of generating impressive long-term returns.
Of course, this does not mean that investors should sell all stocks and only hold cash due to the threat of a stock market crash. However, having cash on hand at all times may be a prudent step to take given the difficult economic outlook.
Identify quality companies
Some high-quality stocks rallied sharply after the 2020 stock market crash. As such, they may no longer offer a margin of safety. Identifying them and waiting for their prices to reach a lower level during a future market decline could be a profitable decision. It can allow an investor to access the best companies in a specific industry when they offer significant capital growth potential.
Warren Buffett has always sought out the most attractive companies at the lowest prices. He generally avoided buying cheap stocks. Instead, he focused on companies with large economic moats that can generate relatively strong profit growth over the long term.
By making a list of the most attractive companies before a stock market crash, an investor can be prepared to act on temporary market pricing errors. As the market downturn this year has shown, stock prices can sometimes trade at low levels for a short time. Therefore, undertaking the necessary research now to determine which stocks to buy if the price drops at a later date might be a logical strategy. This can allow an investor to follow Warren Buffett’s lead in buying high quality companies when trading low.
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Motley Fool contributor Peter Stephens has no position in any of the stocks mentioned. The Motley Fool Australia does not have a position in any of the titles mentioned. We fools may not all have the same opinions, but we all think that diverse range of information makes us better investors. The Motley Fool has a disclosure policy. This article only contains general investment advice (under AFSL 400691). Authorized by Scott Phillips.