The stock market’s 100% gain since the March 2020 crash seems to have caused a degree of excitement among investors. Indeed, the Volatility Index (VIX), which measures sentiment among investors via a standalone figure, now has a reading of 22. This is significantly down from the 66 level in April 2020, with a lower figure indicating greater investor confidence.
Of course, heightened excitability among investors could cause them to rapidly buy and sell shares in the hopes of generating a quick profit. They may wrongly assume the stock market’s recent gains will persist for many weeks, months or even years. This could mean they end up holding shares that are overvalued and hardest hit by the next bear market.
In addition, a strategy that relies on buying and selling stocks in quick succession could lead to high expenses. Commission costs have fallen dramatically over the past couple of decades. However, alongside tax considerations, they could be severely detrimental to an investor’s returns over the long run.
Buffett’s approach
Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) Chairman Warren Buffett (Trades, Portfolio) has previously highlighted the risks posed by higher expenses and greater excitement. As he once said, “Investors should remember that excitement and expenses are their enemies.”
Buffett has a long track record of avoiding both of those threats. For example, he has an extremely long-term view that means Berkshire has bought and held a relatively low number of stocks over recent decades. Indeed, it first purchased Coca-Cola (KO, Financial) in the aftermath of the 1987 stock market crash. Similarly, he first purchased American Express (AXP, Financial) in 1963. Both stocks remain key holdings in Berkshire’s portfolio.
A buy-and-hold approach reduces commissions and, depending on an investor’s circumstances, taxes because capital gains remain unrealized. Furthermore, such a strategy may provide portfolio holdings with sufficient time to deliver on their potential. New strategies, refreshed management teams and revised products can all take time, perhaps even several years, to produce an economic moat capable of catalyzing a firm’s financial performance.
A stable outlook
In addition, Buffett seems to lack the tendency of many investors to become excited as their holdings rise in value. Indeed, it could even be argued that he becomes more upbeat when share prices are lower because it provides him with more plentiful opportunities to buy high-quality companies at low prices.
Clearly, adopting such an attitude can be difficult – especially when an investor’s portfolio value is rising during a bull market. However, investors who are able to follow Buffett’s lead in maintaining a stable outlook however the stock market is performing may find it easier to rely less on emotions and more on logic when managing a portfolio. Ultimately, this may lead to a more efficient allocation of capital.
