If a Stock Market Crash Is Coming, History Says Following These 6 Words From Warren Buffett Is the Smartest Move You Can Make

Investors have had plenty to celebrate over the past four years. The S&P 500 (^GSPC -0.30%) has gained nearly 115% since the fall of 2022, while the Dow Jones Industrial Average (^DJI -0.25%) has gained nearly 80%, and the Nasdaq Composite (^IXIC -1.38%) has jumped more than 150%.

And while it’s fallen somewhat in the past two weeks, it was just earlier this month that the tech-heavy Nasdaq-100 notched another all-time high.

But as welcome as those gains are, they can also make investors uneasy. It’s natural. Many investors are wondering if a crash is incoming. So, now is as good a time as ever to consider sage advice from Warren Buffett, one of the most successful investors of all time.

Stock market highs don’t predict a crash

First, while it might feel otherwise, the stock market recording all-time highs isn’t, by itself, a reason to expect trouble. It’s all too common for success to make people uneasy.

But consider this: The investment firm Dimensional Fund Advisors looked at S&P 500 data from 1926 through 2022 and found that a year after setting a record, the index was higher 81% of the time and gained an average of nearly 14%.

Of course, crashes still happen. They are a fact of life in the stock market. So, what can we learn from the Oracle of Omaha when the next one happens?

How Warren Buffett profited from market fear

One of Buffett’s most famous quotes dealt with watching for herd behavior in the market and running in the opposite direction. Since we’re talking about benefiting from crashing prices, we’ll stick to the second half of the quote: “Be greedy when others are fearful.”

These six words can help you avoid the worst thing you can do during a crash: panic sell. Instead, his advice can help you see a crash as an opportunity: a chance to buy shares of great businesses at steep discounts. For those who can keep their heads, a stock market crash can be lucrative.

Image source: Getty Images.

A perfect example of this advice in action: the great financial crisis. While most investors were running scared, Buffett poured billions into several companies when confidence was in short supply. This wasn’t charity: He helped the companies raise cash when they needed it most while ensuring Berkshire Hathaway shareholders made money — a lot of it.

Here’s a rundown of his work in 2008 and the years that followed:

1. Goldman Sachs: Berkshire invested $5 billion in September 2008, receiving preferred shares paying a 10% dividend and warrants — the right to buy shares at a set price. The deal generated $3.7 billion in profit.
2. Bank of America: Berkshire invested $5 billion in 2011 as the bank continued to struggle after the crisis. Again, Buffett secured preferred shares and warrants. When he exercised those warrants in 2017, Berkshire had an on-paper gain of $12 billion.
3. General Electric: Buffett invested $3 billion in the struggling industrial giant in 2008, securing preferred shares and warrants. The investment produced $1.5 billion in profit over nine years.

Buy great businesses, not just cheaper stocks

Of course, you have to be careful. A cheap stock isn’t automatically a bargain. There are plenty of stocks that fall in a crash and never recover because the underlying business was bad.

This is why it’s important to keep in mind two more quotes from Buffett: “Charlie and I are not stock-pickers; we are business-pickers” and “When we own portions of outstanding businesses with outstanding management, our favorite holding period is forever.”

When you buy a stock, you are buying a small ownership stake in a business. If that business is a quality business, if it has a durable competitive advantage and is run by competent leadership, it’s a fair bet that after the dust settles, that business will grow its profits over time. A lower share price gives you the chance to own a piece of those future earnings for less money.