Warren Buffett Suggests Successful Investing Requires Discipline

Warren Buffett is probably the most highly regarded investor of our era. Over the years, he has offered the following wisdom:

• “Inactivity strikes us as intelligent behavior.”

• “The only value of stock forecasters is to make fortune-tellers look good.”

• “We continue to make more money when snoring than when active.”

• “Our stay-put behavior reflects our view that the stock market serves as a relocation center at which money is moved from the active to the patient.”

In addition to these words of caution, Buffett recommends that if you simply cannot resist the temptation to time the market, then you “should try to be fearful when others are greedy and greedy only when others are fearful.”

The following data on the intra-year declines of the S&P 500 Index should convince you of the prudence in Buffett’s advice.

• For the 36-year period from 1980 through 2015, the S&P 500 experienced an average annual intra-year decline of more than 14%.

• The worst intra-year decline, of 49%, occurred in 2008.

• There were three other years (1989, 2001, and 2002) when the intra-year decline was at least 30%. That’s a total of four years (or 11% of the calendar years in our period) with intra-year declines of at least 30%.

• There were an additional two years (1990 and 2009) when the intra-year decline was at least 20%. That’s a total of six years (or 17% of the calendar years) with intra-year declines of at least 20%.

• There were an additional seven years (1980, 1981, 1982, 1998, 2000, 2010, and 2011) when the loss was at least 15%. That makes a total of 13 years (or 36% of the calendar years) with intra-year declines of at least 15%.

• There were an additional seven years (1984, 1997, 1999, 2003, 2007, 2012, and 2015) when the intra-year losses were at least 10%. That’s a total of 20 years (or 56% of the calendar years) with intra-year declines of at least 10%.

• Despite experiencing intra-year losses of at least 10% in 56% of years since 1980, the S&P 500 provided positive returns in 27 (or 75%) of those 36 years.

Thanks to analysis from my colleague Dan Campbell, part of the investment strategy team at Buckingham, and The BAM ALLIANCE, we can also take a look at some longer-term data. Dan examined how the S&P 500 Index performed following a poor start to the year. The data covers the 90-year period from 1926 through 2015.

• There were 33 years (or 37% of them) in which the S&P 500 produced a loss during the first quarter. By the end of 18 of those 33 years (or 55%), the S&P 500 had produced a gain. Of those 18 years, the highest full-year return occurred in 1933, when the S&P 500 returned 54%. The best performance over the last three quarters in each of those 18 years was also in 1933, when the S&P 500 returned 79.2%. The last time the first quarter ended in negative territory but full-year returns turned positive was just recently, when in 2009, the first quarter finished with a return of -11% and went on to recover for full-year gains of 26%.

• There were 31 years (or 34% of them) in which the S&P 500 produced a loss during the first six months. By the end of 11 of those 31 years (or 35%), the S&P 500 had produced a gain. Of those 11 years, the highest full-year return occurred in 1982, when the S&P 500 returned 21.4%. The best performance over the last half in each of those 11 years was also in 1982, when the S&P 500 returned 31.7%.

• There were 25 years (or 28% of them) in which the S&P 500 produced a loss during the first nine months. By the end of five of those 25 years (or 20%), the S&P 500 had produced a gain. Of those five years, the highest full-year return occurred in 1982, when the S&P 500 returned 4.0%. The best performance over the last quarter in each of those five years occurred just recently, when in 2011 the S&P 500 returned 11.8% over the final three months.

We’ll take one more look through the data, this time focusing on the S&P 500 Index’s worst performance over calendar quarters. The period we will examine is from 1980 through 2015. There are 144 quarters during this timeframe.

• The worst calendar quarter occurred in the fourth quarter of 1987, when the S&P 500 lost 22.6%. This was followed closely by the 21.9% loss experienced in the fourth quarter of 2008. Those were the two calendar quarters in which losses exceeded 20%.

• There was one additional calendar quarter when the S&P 500 lost at least 15%, for a total of three (or 2% of calendar quarters in the period) that lost 15% or more.

• There were an additional 10 calendar quarters when the S&P 500 lost at least 10%, for a total of 13 (or 9% of calendar quarters) that lost 10% or more.

• There were an additional six calendar quarters when the S&P 500 lost at least 5%, for a total of 19 (or 13% of calendar quarters) that lost 5% or more.

I would add that in the first quarter of 2016, the S&P 500 Index lost more than 6%, providing investors with one more test of their discipline. How the full year turns out remains to be seen.

This data makes clear that markets are highly volatile and that significant losses are a regular occurrence. Thus, your investment plan must incorporate the virtual certainty that your discipline will be tested over and over again.

Warren Buffett has accurately stated that “investing is simple, but not easy.” The simple part is that the winning strategy is to act like the lowly postage stamp, which adheres to its letter until it reaches its destination. Similarly, investors should stick to their asset allocation until they reach their financial goals.

The reason that successful investing remains so hard is that it can be difficult for many individuals to control their emotions — greed and envy in bull markets and fear and panic in bear markets. In fact, I’ve come to believe that bear markets are the mechanism by which assets are transferred from those with weak stomachs and no investment plan to those with a well-thought-out plan (meaning they anticipate bear markets) and the discipline to follow it.

A necessary condition for staying disciplined is to have a plan to which you can adhere. But that’s not enough. The sufficient condition is that you must be sure your plan avoids taking more risk than you have the ability, willingness, and need to assume. If you exceed any of those, you just might find your stomach taking over. The bottom line: If you do not have a plan, develop one. If you do have a plan, and it’s well-thought-out, stick to it.