There’s no shortage of ways to play crime with your retirement nest egg. In fact, there are always plenty of investment options that promise to make you rich…if you trade quickly. It’s just the nature of the business.

Smart investors like Warren Buffett know, however, that playing defense can be just as important (if not more important) than finding big winners at the right time. The Oracle of Omaha explains in very simple terms how you can protect your portfolio from unwanted downside. Here’s a closer look at what he said, and what it means for you.

Don’t be afraid to pay for quality

He’s the brains behind several how-to investing books, and his live interviews are a reliable source of quote-worthy tips. Yet the best nuggets of Warren Buffett’s investment wisdom are found in his annual letter. Berkshire Hathaway shareholders.

Two of these closely related tips remain for the leisure-minded. In a 1989 letter, Buffett wrote “It’s much better to buy a great company at a great price than a great company at a great price.” Then, in a 2008 letter, Buffett quoted Benjamin Graham’s observation that “price is what you pay; value is what you get.” The two ideas are really saying the same thing, though – you should be willing to pay for quality.

Don’t misread the message. A portfolio of high-quality companies is not immune to market-wide pullbacks. On any given trading day, three out of four stocks are moving in the same direction as the broader market; The market tide is that strong. Shares of quality companies tend to hold up well during long periods of market-wide weakness, however, they tend to bounce back better than their more speculative counterparts.

It’s certainly not too late. Quality stocks (stocks of companies with consistent earnings, minimal debt, and reliably strong returns on equity) trailed growth stocks in a red-hot 2020, according to data compiled by Guardian Capital, a trend that began all the way back to 2008. that is When interest rates were moving in the direction of a multiyear expansion of low borrowing costs…a situation that strongly favors growth equities. Quality stocks then underperformed value stocks during the bear market of 2022, losing more ground.

That slow performance is more the exception to the norm, however, is rooted in more unusual circumstances.

It is also a bit of a domestic event. Recent number-crunching by investment research organization IQ-EQ shows that the MSCI World Quality Index has outperformed the MSCI World Growth and MSCI World Value indices since 2000. Notably, IQ-EQ’s research found that the quality-oriented index is the only one of the three to boast benchmark-beating gains for the past five-, 10-, 15-, and 20-year time frames; It is essentially linked to the growth index of the last three years.

Quality stocks outperform growth stocks and value stocks given the long-term timeframe.

Data source: Thomson Reuters. Chart by author.

Data from Guardian Capital shows that while quality stocks have captured only 95% of the overall market’s upside since 1982, while growth stocks have beaten the market by 103%, high-quality stocks have suffered only about 79% of the broader market’s total pullback. Rising global stocks led the charge lower, outpacing overall market losses even more than it led its rallies. Remarkable is the fact that these quality stocks have held up well in the inflationary period we are in now, are less volatile, and continue to report the highest profit margins despite the challenging environment.

And note that the MSCI Quality Index ranks stocks based on various factors, any Which is a valuation, or a price-based comparison to that company’s underlying earnings. In many cases these stocks also look relatively expensive. Its current top holdings are: Microsoft, appleand Nvidia, none of which are valued at less than 20 times their trailing 12-month earnings. In fact, the average P/E ratio of the entire index is now above 20.

Take a hint

Great, but what does this have to do with Warren Buffett, or protecting your retirement savings? More than you might realize on the surface.

Stock picking and buying is a fairly simple task; Anyone can do it. Being able to stick with the stock is the hard part. See, investors — and especially novice investors — can tend to lose sight of the long-term picture when they get distracted by short-term volatility. big mistake This short-term noise can prompt you to bail out of a trade at exactly the wrong time. Or, perhaps worse, the mindset that allows investors to be distracted by the near-term noise in the first place often leads to too much trading activity. That in itself is a recipe for poor performance.

The solution? Stick with stocks you can confidently continue to own for the long haul even when things turn ugly. Focusing on the value you’re getting rather than the price you’re paying allows you to do this comfortably. Other, lower-quality holdings carry the risk of forcing you to cut big losses before anything bigger.

In other words, the premium you pay for quality stocks eventually pays for itself.

James Brumley has no position in any of the stocks mentioned. The Motley Fool has positions on and recommends Apple, Berkshire Hathaway, Microsoft, and Nvidia. Motley Fool has a disclosure policy.

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