This Warren Buffett Quiz Might Help You Survive a Market Crash

Stock markets around the world have been on the rise.

In the US, the Dow Jones Industrial Average, a widely-followed market barometer, climbed above the 20,000 mark for the first time ever in January – it is currently at 20,550 points.

At home, the SPDR STI ETF (SGX: ES3) – a proxy for Singapore’s market barometer, the Straits Times Index (SGX: ^STI) – has risen almost 23% since hitting a low in mid-February last year.

The rise in stock prices can be both exciting and scary at the same time. To some, a rapid climb is a sign that the market is poised for a crash.

A quiz from the past

Billionaire investor Warren Buffett is the long-time Chairman of the US-based conglomerate, Berkshire Hathaway. In 1997, Buffett wrote a short quiz in his annual letter to Berkshire’s shareholders. Back then, the market was rising, much like today. Buffett wrote:

“A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices?

These questions, of course, answer themselves.”

The premise here is simple. If you are a fan of hamburgers, given the choice, would you prefer to pay a higher or lower price for your hamburgers? Buffett believes that the answer should be obvious. But there is a second part to the quiz. Buffett followed up:

“But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period?”

Unlike the first question, Buffett believes that the common investor will likely fumble on this question. He said:

“Many investors get this one wrong.

Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying.

This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.”

In short, Buffett believes that investors should not fret over when a market crash will happen. Historically, market declines have happened from time to time. Many more will happen in the decades ahead.

But instead of worrying over a crash, the common investor should be elated to have lower stock prices as it could provide opportunities to invest in good companies on the cheap.

Keeping a portion of your portfolio in cash to be ready for such a situation could be worth considering.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong owns shares of Berkshire Hathaway.