Warren Buffett Says Investors Could Be "Playing With Fire." Here's the Best Way to Protect Your Portfolio.

Despite some rough patches earlier this year, the stock market has been thriving throughout most of 2025. The S&P 500 (SNPINDEX: ^GSPC) is up by more than 14% as of this writing, surging by a whopping 35% since its April lows.

But unbridled growth isn't always a good thing, and some investors are worried that we're in an overvaluation bubble that's about to pop. While nobody knows for certain what's coming for the stock market, the famed Buffett Indicator suggests that investors could be "playing with fire" right now.

Here's what you need to know.

Image source: The Motley Fool.

The Buffett Indicator is in risky territory

The Buffett Indicator is a ratio comparing the total U.S. stock market value to GDP, popularized by Warren Buffett after he used the metric to correctly predict the dot-com bubble burst in the late 1990s.

In a 2001 interview with Fortune magazine, Buffett looked back at his prediction and explained how he knew stocks were about to plummet. "For me, the message of that chart is this: If the percentage relationship falls to the 70% or 80% area, buying stocks is likely to work very well for you," he said. "If the ratio approaches 200% -- as it did in 1999 and a part of 2000 -- you are playing with fire."

As of October 2025, the Buffett Indicator ratio sits at around 220%. For context, the last time this ratio peaked was in November 2021, topping out at close to 193%. Just a couple of months later, stocks descended into a bear market that lasted nearly a year.

To be clear, this figure doesn't mean that a recession or market crash is imminent. No stock market indicator is foolproof, and as company valuations increase over time, the Buffett Indicator ratio may not be as accurate as it was decades ago. In fact, the last time the ratio dipped below 80% -- the zone Buffett suggested was the safest for investors -- was in 2012.

How to protect your investments against a market downturn

Regardless of whether a market downturn is coming soon or takes a bit longer to arrive, we'll eventually face one. The good news, though, is that there are a few simple steps that can protect your portfolio, no matter what's on the horizon.

1. Keep at least some cash on hand

One of the biggest risks during a recession or bear market is having to withdraw your money after stock prices have plummeted. If you throw all of your spare cash into stocks but then lose your job or face a hefty unexpected expense after prices have fallen, you might have no choice but to sell your investments for far less than you paid for them.

Right now is a smart time to ensure you have a robust emergency fund with enough cash to cover at least three to six months' worth of general living expenses. If you don't have any emergency savings, it could be smart to hold off on investing for the time being so you can focus on building up your safety net.

2. Stay focused on the long term

It can be tempting (yet stressful) to keep up with what the market is doing on a daily basis. If you're already worried about a looming downturn, even minor dips can feel like disaster. But short-term fluctuations are normal even in strong economic times, and the market's long-term performance is far more important than these daily ups and downs.

In 2008, Warren Buffett penned an opinion piece for The New York Times to help reassure discouraged investors amid the Great Recession, saying of the market's performance over the previous decades:

You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.

The short-term future of the market could be bleak, but that's OK. Its long-term performance is what really matters, and that outlook is incredibly bright.

3. Ensure you're investing in the right places

A strong portfolio is key to surviving a market downturn, and right now is the perfect opportunity to unload any shaky stocks while prices are still high.

The best investments are stocks from fundamentally sound companies with healthy foundations. Organizations with an experienced leadership team, a competitive advantage in their industry, and a long-term financial plan, for example, are more likely to survive economic hardship. And the more of these stocks you own, the stronger your position will be heading into a potential recession or bear market.

The Buffett Indicator may suggest we're in a stock market bubble that's close to bursting, but nobody really knows what's ahead. For now, the best thing you can do is keep a level head and take whatever steps you can to prepare your investments accordingly.

Katie Brockman has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.