Warren Buffett's advice is prized by everyday Americans and presidents alike. Official White House Photo by Pete Souza.
If anyone knows how to weather a financial crisis, it's Warren Buffett. Between October 2008 and March of 2009, in the depths of the Great Recession, shares in Buffett's company Berkshire Hathaway dropped 32% -- and yet, thanks to the excellent performance of the many companies Berkshire owns, the conglomerate's book value only decreased 9.6% during 2008. Take a look for yourself:
Warren Buffett knows how to spot companies that will survive just about any crisis the economy can throw at them. In his recent letter to shareholders, Buffett highlighted the three factors that have helped him achieve such reliable returns:
What this means for your investmentsWith the stock market trading higher than anyone would have thought five years ago, many are starting to worry that their portfolios are vulnerable to a crisis. Using Buffett's three tenets, we can see what kind of companies you should have in your portfolio if your main goal is to weather the next financial storm relatively unscathed.
Companies that provide the absolute necessities are most likely to provide a "large and reliable stream of earnings," often helped by a strong brand. We're talking about stocks like American Express , Coca-Cola , and Google . None of these three are heady growth stocks, but during a pinch, people will still use their credit cards, buy soda and bottled water, and search for information online.
Things start to get interesting when we talk about "massive liquid assets." Buffett expanded on his reasoning by saying, "Cash ... is to a business as oxygen is to an individual: never thought about when it is present, the only thing in mind when it is absent." When it comes to Berkshire, he sets the bar at a minimum of $20 billion in cash on hand.
Looking at our three example companies, they are mostly following suit:
Source: Yahoo! Finance.
Finally, Buffett calls for companies that "have no significant near-term cash requirements." Buffett was specifically referring to derivative contracts and other investments that incur massive losses resulting from panic triggered by major unforeseen events (Buffett uses Pearl Harbor and September 11 as examples).
Although none of the three companies above have that type of exposure, the argument could be made that Google is currently spending too much money on a yearly basis to pass this final hurdle: the company's perating expenses have increased by 60% to $23.8 billion in the past two years alone.
Perhaps that explains why American Express and Coke are massive holdings for Buffett and Google isn't. The list of stocks that could pass these three tests doesn't stop here, but these serve as examples of how to vet them.
What this means for youBut you shouldn't apply these principles to your investment choices alone; they should be applied to your personal finances as well. Consider taking these steps to adhere to Buffett's approach, and you'll find yourself far more recession-proof:
- A reliable stream of earnings: Staying in one job for the long haul is a great way to earn the confidence of your employer. But even then, nothing is certain. Make sure you have disability and life insurance to provide a reliable stream of earnings if something should happen to you.
- Massive liquid assets: Here's a point that many Americans fail to heed. At a bare minimum, you should have enough money set aside to provide for you and your family for six months if you lose all sources of income. Keeping a little cash on hand to take advantage of stock market dips can pay off as well; then, while other investors panic-sell, you can buy shares of your favorite companies at a discount.
- No significant near-term cash requirements: This can be a little tricky if you're just about to buy a house or send a child off to school. But in the end, what Buffett is really talking about here is being smart with your money -- i.e., not going to Vegas and making bets that you can't afford to lose.
In the end, applying Buffett's wisdom to both your investing and your personal life will help ensure that you're ready to handle whatever our economy throws at you.
The article Warren Buffett: 3 Ways to Protect Your Savings From a Crisis originally appeared on Fool.com.
Brian Stoffel owns shares of Berkshire Hathaway, Google (A shares), and Google (C shares). The Motley Fool recommends American Express, Berkshire Hathaway, Coca-Cola, Google (A shares), and Google (C shares). The Motley Fool owns shares of Berkshire Hathaway, Google (A shares), and Google (C shares) and has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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