What can Warren Buffett teach us about investing in uncertainty?
It hasn't been an easy ride over the past few years. Just as there seemed to be some light at the end of the tunnel after the pandemic, it's unlikely anyone expected a war so close to home.
The Ukraine crisis is a devastating tragedy, and one that could have lasting consequences. The main hope around the globe is for resolution and successful peace talks.
Many have seen the impact the crisis has had on markets and are aware of the influence it will have on further inflationary spikes. We were already dealing with the reality of rises to the cost of living, and the conflict has only amplified this.
It's a fast-moving situation, so there'll likely be more ups and downs to come. But if history has taught us anything, it's that markets are resilient over the long term.
We've looked at one of the most successful investors of all time, Warren Buffett, to see what he can teach us about preparing for times of uncertainty.
This article isn't personal advice. If you're not sure if something is right for you, ask for financial advice. Comments correct as at 6 April 2022.
The 'Oracle of Omaha'
Having successfully run Berkshire Hathaway, a holding company for a variety of businesses, for over 50 years, Warren Buffett has lived through his fair share of uncertain times.
Despite owning a wide mix of companies, Buffett's Berkshire Hathaway has seen its value fall by more than 30% six times between 1979 and 2019. In early 2000, Berkshire lost 44%.
However, Buffett is currently the eighth richest person in the world and has been dubbed the 'Oracle of Omaha' from his investment choices. There are some valuable lessons we can learn from his experiences.
Be fearful when others are greedy and be greedy when others are fearful.
One of Buffett's most famous quotes tells us we should keep our cool when it comes to investing.
Share prices and the stock market can overreact in the short term. Investors' emotions can come to the fore and share prices can move away from what the company's really worth. The difference between price and value is essential for investors.
When markets seem to be taking a turn for the worst, it's essential to hold your nerve and think long term.
Of course, we need to watch out for the opposite too. When investors get carried away, prices can rise to unsustainable levels – like we saw in the dotcom bubble of the late 90s. This is when Buffett tells us to be fearful.
Remember though, all investments can fall as well as rise in value, so you could get back less than you invest.
Highs and lows in a market are nothing unusual. Buffett believes if you're looking to add to your portfolio, falling share prices can offer opportunity.
History has shown that buying when valuations are lower can push the odds in an investor's favour and yield a greater chance of profit.
If you don't feel comfortable owning a stock for ten years, you shouldn't own it for ten minutes.
This mindset has led him towards companies he labels as "inevitables" – those with extraordinary longevity and dominant market positions, allowing them to generate attractive returns for shareholders year after year.
If you're looking for individual companies, your first step should be finding a business with solid financials – this means a strong balance sheet with manageable levels of debt. With interest rates rising recently and debt therefore becoming more expensive, managing it has become even more important.
You'll need to look for companies with strong free cash flow, revenue, and growing profits.
That's not to say you shouldn't think about companies with the potential to grow. High-growth businesses are typically valued based on their potential, so the underlying figures don't always warrant their price.
These companies might still have some hurdles to overcome, but if you think they can stand the test of time, they could be worth your attention.
The main message
Reading blaring headlines or seeing the value of your investments fall can be nerve-wracking. There'll always be some bumps along the way, but that's the nature of investing.
Looking at some of the biggest falls in value of the UK stock market since 1985 and how long it took to recover, tells us why it's key to take a long-term approach to investing. For these examples we assumed you'd invested at the highest point before the market started to fall.
Chart showing UK stock market performance following drops
The key point is tough times don't last forever, and markets have eventually recovered. As always with investing, there are no guarantees.
It's important for investors to think back to their long-term strategy and stay resilient when markets are jittery. Make sure you're happy with the level of risk across your investment portfolio – the more risk you take on, the bigger the potential drops.
No matter what happens, good investing principles stay the same. So, while you can't always control how your investments perform, you can control how you prepare your portfolio.
Investing in lots of companies in a similar category can only give you so much insulation when that style goes out of favour. We believe as long as you're diversified, what you buy isn't always the most important factor.
How much you invest and how long for are far more important. So, start early and keep adding as you go.
We think one of the best ways of diversifying a portfolio is by investing with the best fund managers, in different parts of the world.
Before investing it's important to check the fund's objectives align with your own, understand the fund's specific risks and if there's a gap in your portfolio for that type of investment.
Remember, investing is a test of nerve and knowledge, and experience is an asset you simply can't buy. So be patient, be diversified and let time do the hard work for you.
We've covered what you need to know about how to invest well over the long term, and make the right decisions for your financial future.
Be tax efficient – take your helping hand
While uncertainty and volatility are two trending topics across financial markets right now, other areas of our finances look a bit more certain, but not in a good way – the cost of living is on the rise.
The 'cost of living' is a measure of people's 'real' incomes. It covers a range of different things, from inflation and household bills, to wage growth and taxes. So, why is it rising?
Inflation is playing a big role. That's the price you pay for everyday goods and services, like petrol, food and other essentials. It's risen at its fastest pace in 30 years to 6.2% in the 12 months to February with expectations it could rise above 7% in April (when the energy price cap goes up by 54% on average). And inflation could go even higher as the Ukraine crisis continues to escalate.
UK taxes have risen too. The government has announced a rise in National Insurance and dividend tax. The new rules are effective from 6 April 2022, squeezing incomes further for many households.
In times like these, it's more important than ever to make the most of the tax advantages available. The government currently offers generous incentives that encourage us to save and invest for our future, but there's nothing to say they'll be around forever.
So, where it's right for your circumstances, make sure you take advantage of any help you can get. This is where ISAs and pensions come in.
There are no guarantees with investing, but you can improve your chances of success by not paying more tax than you need to. The more money you can shelter away from tax, the harder it can work for you.
Investing is best for the longer term, but remember to regularly review your investments. By compounding more of your money for longer, you could improve your returns. Watch our short video to see how compounding works and how powerful it can be.
Unlike cash, all investments can fall as well as rise in value, so you could get back less than you invest. Tax rules can change, and benefits depend on personal circumstances.
This article isn't personal advice. If you're not sure what's best for your circumstances, ask for financial advice.
The power of compounding
Stocks and Shares ISAs
By making your portfolio as tax efficient as possible, you're actually improving your returns before you even start investing.
One of the easiest ways to start investing tax efficiently is to invest in a Stocks and Shares ISA. All investments in an ISA are free from UK income and capital gains tax.
The vast majority of investments can be held in a Stocks and Shares ISA. This offers investors plenty of variety and choice on where to invest, as well as the means to build a nicely diversified portfolio. Whether you're a conservative investor looking for a steady income, or seeking a more adventurous way to grow your wealth, you can invest with the confidence of knowing any profits or income are sheltered from tax.
Rates of tax | Basic-rate taxpayer | Higher-rate taxpayer | Additional-rate taxpayer | ISA investor |
|---|---|---|---|---|
Capital gains (in excess of the £12,300 annual allowance) | 10% | 20% | 20% | 0% |
Dividend income over £2,000*(i.e. income from shares) | 8.75% | 33.75% | 39.35% | 0% |
Interest income (i.e. from cash, corporate bonds and other fixed interest investments)* | 20% (over £1,000) | 40% (over £500) | 45% | 0% |
The table refers to the tax year 2022/2023. Tax rules can change, and benefits depend on individual circumstances. *This example assumes an individual has fully used their personal allowance and none of the interest falls within the starting rate for savings.
Each tax year (6 April to 5 April), there's a limited amount of money you can put in ISAs. This tax year the ISA allowance is £20,000. It's not possible to carry forward allowances from previous tax years. So if you haven't already, make the most of this year's ISA allowance before it's gone.
Pensions
Another way to benefit from tax-free investing is to invest in a pension for your retirement.
One key advantage is that you can get tax relief on what you put in. The government will top up your personal pension contributions by 20%. So, to have £100 in your pension, you'd only need to contribute £80. Those who pay tax at a higher rate might be able to claim back even more.
Your pension contributions, including any made by your employer, are limited by the annual allowance which is currently £40,000 each tax year for most people. You'll only get tax relief on personal pension contributions up to 100% of your UK earnings, or £3,600 if this is greater (if you're a low or non-earner).
Similar to ISAs, you'll benefit from growing your money free from UK income tax and capital gains tax. However, with a pension you can't normally take money out before you're 55 (57 in 2028).
It's worth pointing out that on average, over the very long term with dividends reinvested, the UK stock market has grown by 9.1% a year to 31 December 2021. By investing in a pension and getting at least 20% back in tax relief, you're effectively giving yourself a head start. Past performance is not an indication of what will happen in the future as nothing is certain.
The chart below shows how much you'd have made when the FTSE All-Share index began, just over 33 years ago. If you'd invested £8,000 or £10,000 in a pension (£8,000 plus the current basic-rate tax relief of 20%). Remember tax rules can, and will, change.
The chart is an illustration based on a lump sum, which excludes charges and inflation. Please note you can usually take 25% of your pension pot tax-free with the rest taxed as income.
In this case, the difference between receiving basic-rate tax relief and not is more than £46,000. And those who pay more than basic-rate tax could've received thousands more through further tax relief as well.
Modern pensions, like the HL Self-Invested Personal Pension (SIPP), tend to offer more investment flexibility than traditional pensions – you can choose when, where and how you invest. This kind of flexibility gives you the ability to tailor your portfolio to suit your needs and wants, and help you achieve your long-term investment goals.
Unlike a lot of things, pensions typically get better with age – the earlier you start, hopefully the bigger the pot.