Buffett, Graham, And Klarman On How To Invest In A Recession

Buffett, Graham, And Klarman On How To Invest In A Recession
Theodora Lee Joseph, CFA

over 1 year ago5 mins

  • A recession isn’t all bad news: market declines are valuable opportunities to pick up quality companies at good prices.

  • To outperform the market, be patient, keep a long-term outlook, and tune out short-term fluctuations in share prices.

  • Knowledge compounds just like returns, and ultimately, the best returns you can make over a lifetime come from investing in yourself.

A recession isn’t all bad news: market declines are valuable opportunities to pick up quality companies at good prices.

To outperform the market, be patient, keep a long-term outlook, and tune out short-term fluctuations in share prices.

Knowledge compounds just like returns, and ultimately, the best returns you can make over a lifetime come from investing in yourself.

Mentioned in story

With the US economy having now slipped into a technical recession, value investing – finding stocks that look cheap relative to the market – might be about to come back into fashion. So I’ve gathered some words of wisdom from Warren Buffett, Seth Klarman, and Benjamin Graham, and laid out what these three maestros recommend at a time like this.

"Bad news is an investor's best friend. It lets you buy a slice of America's future at a marked-down price."

Berkshire Hathaway CEO Warren Buffett sees market declines as valuable opportunities to pick up quality companies at good prices. Cyclicality is part of the market, he points out, and the stock market tends to trend upwards over the long term. Case in point: the United States has endured the Great Depression, a World War, a dozen or so recessions, and several financial panics in the past 100 years, but the value of the Dow Jones Industrial Average has risen 400 times in that period.

“People should be highly skeptical of anyone's – including their own – ability to predict the future, and instead pursue strategies that can survive whatever may occur.”

Defensiveness is a good approach to take in a recession, says Baupost Group CEO Seth Klarman. The market is likely to go against you, after all, and it’s more important to keep your portfolio in one piece than to shoot for maximum returns. So Seth thinks you should look for companies with a strong balance sheet and healthy cash flows: their stocks mightn’t outperform when the market’s in a good place, but they will provide you security to fall back on when times get tough.

“Invest only if you would be comfortable owning a stock even if you had no way of knowing its daily share price.”

Our ability to track share prices so closely comes at a cost: it can lull you into a false sense of optimism when you see share prices that have risen consecutively for days in a row, or into panic if the reverse happens. But economist and “father of value investing” Benjamin Graham points out that how a stock performed in the last week doesn’t tell you anything about how it will perform in the next few days, months, or years. Returns alone – especially over short periods of time – barely reveal anything about the quality of your investment decisions. If you want to outperform the market, you’d do better tuning out short-term fluctuations in stock prices and focusing on your overarching investment thesis.

"An investor is better off knowing a lot about a few investments than knowing only a little about each of a great many holdings. "

The principle behind another of Klarman’s mantras is simple: you don’t need loads of good investment ideas to be a successful investor, just need a few great ones. That’s because it’s often just one or two high-conviction ideas in your portfolio that drive the majority of the best investors’ returns. That means they take time doing their homework on a company, its product, its industry, and its competitors, and aren’t interested in using their investment capital until the right opportunity arrives.

“The risks of being out of the game are huge compared to the risks of being in it."

No one knows the future, and even the experts generally have a poor track record at predicting when the market will turn. That’s why Buffett thinks dipping in and out of investments based on “the turn of tarot cards, the predictions of ‘experts’, or the ebb and flow of business activity” is one of the biggest mistakes an investor can make. After all, if you’d missed the best 10 days of the market between 2001 and 2020, you’d have made less than half what you’d made if you never withdrew at all.

Time in the market is more important than timing the market

"Because investing is as much an art as a science, investors need a margin of safety.”

The simplest way to make a profit is, simply put, to avoid making a loss. But that doesn’t mean staying away from the market altogether: instead, Klarman argues that you should invest in assets with “a margin of safety”. To Seth, that means those “purchased at prices sufficiently below underlying value to allow for human error, bad luck, or extreme volatility in a complex, unpredictable, and rapidly changing world." That hasn’t been easy in the past decade, when stocks have been so high that value was hard to come by. But now that stocks are under more pressure, this margin of safety should be a priority.

“The most important investment you can make is in yourself.”

Buffett is a big fan of the idea that knowledge compounds just like returns, which means you’ll make more in the long run if you never stop learning. Knowledge, he argues, can’t be taxed, won’t be eroded by inflation, won’t be dented by a recession, and is completely in your control.

“The single greatest edge an investor can have is a long-term orientation.”

Klarman doesn’t think you need to be a genius when it comes to investing, but you do need patience. It’s hard to go against the crowd, especially when markets are in the red. But if you have the discipline to invest your surplus funds while everyone else is predicting doom and gloom, you stand to reap the rewards in the long term.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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