The Survivors’ Guide To The Stock Market

Rule No. 1: Never lose money.

Rule No. 2: Never forget rule No. 1.

– Warren Buffett

Buffett personally lost about $23 billion in the financial crisis of 2008, and his company, Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B), lost its revered AAA ratings.

If Warren Buffett, one of the most successful investors of the past 50 years, can take a pounding of this magnitude and still survive, how can an ordinary investor survive when the next bear market arrives?

The answer can be found by looking at the way Master investors like Buffett have survived and thrived over the long term. These investors not only have stock picking skills, they also have the temperament to navigate the rough waters of bear markets and economic recessions without blowing themselves up. Most investors are not equipped to handle extreme adversity in the markets, but it can be done with proper guidance.

Investing at a Master level requires many different skills. For example, stock picking, market timing, and reading investor sentiment. Anyone can get lucky with these techniques over a few months or a couple of years. But the true Masters operate on a higher level of skill and awareness.

Situational Awareness

If you want to survive over the long term you have to learn how to recognize the forces at play in every market environment. For example, when the market is booming as it has been since March of 2009, the best investors are constantly looking out for signs of trouble. Sure, it’s great that the market is breaking all kinds of records for longevity and magnitude, but wise investors always keep their eyes on the exit instead of throwing every dime they have at the bull market.

Two of the most important indicators that Master investors watch are earnings trends and business cycle trends. There are many other indicators of course, but these two are particularly important for investors who want to protect their capital.

History tells us that economic recessions come along about every 8 years on average, and the growth rate of corporate earnings tend to decline about 6 months ahead of the peak in the business cycle. Furthermore, the stock market – being a forward-looking mechanism – tends to top out about 4 months before the business cycle peaks. These are the kind of big-picture trends that Master investors pay close attention to.

Self Awareness

Adam Smith, in his classic book The Money Game, famously said, “If you don’t know who you are, the stock market is an expensive place to find out.” In my opinion, this is one of the most profound observations ever made about the art and science of Master investing. But what does it mean, exactly?

First, it means that if you want to excel as an investor you must be willing to look for and recognize your biases, tendencies, and assumptions. This isn’t an easy task. It took me years to finally recognize that I had a tendency to hold on to losing positions for too long. When I corrected this flaw in my thinking my returns went up by a significant amount.

Another example of self-awareness is knowing what your pain level is and making allowances for it in your decision-making process. Most investors will say, without thinking, that they can tolerate a drop of 20% in the value of their portfolio. This is rarely accurate. In the real world, a drop of 10% will create enough anxiety to push the average investor to begin selling off parts of their holdings because they fear that the 10% decline will turn into a 20% or worse decline.

When you understand your true pain threshold you have a much better chance to act rationally when the market misbehaves, and your cooler head will prevail.


On the surface it doesn’t seem like humility has any place in an investor’s toolkit. But it does. Having humility means that you recognize that you aren’t smarter than the market, and you aren’t smarter than the professionals who regularly eat your lunch. The opposite of humility is hubris, and hubris is rampant among the investor class. Hubris is a performance killer. Choose humility over hubris and you will survive much longer in the Money Game.

Having a Contingency Plan

It’s very easy for an investor to get caught up in the current market regime and lose sight of the fact that all market regimes eventually end and a new regime takes control. I’m referring to the bullish regime and the bearish regime, and I make no judgement about which is superior.

When the market is in a bullish regime, as we have been for the last 10 years, many investors become True Believers and can’t fathom the possibility that the good times will come to an end. The same can be said for a bearish regime, like we saw in 2008, 2000, and 1929. When everything around you is falling apart it’s hard to muster the courage to step up to the plate and buy stocks that are on sale at ridiculously low prices.

This is where a contingency plan can make the difference between survival and total annihilation. Master investors have a well-thought-out contingency plan that guides them through the tough times. Just as their radar worked to get them out of harm’s way at the top, the contingency plan gets them back in, in stages, when the bear market is nearing its end.

Final thoughts

In this article I have barely scratched the surface of examining what it takes to survive and thrive as an investor. I’m in the process of writing a book on this topic and hope to have it out sometime this year.

Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.