If a Stock Market Crash Is Coming, Warren Buffett's Playbook Says Do This 1 Thing Right Now

Fourteen recessions. Four major bear markets. A scary financial crisis. A global pandemic. Warren Buffett has survived and thrived through all of them.

Despite earning the nickname of "the Oracle of Omaha," Buffett would be the first to tell you that he didn't predict any of those challenging periods in advance. However, he probably knows better than nearly any investor on the planet the best way to navigate turbulent times.

Today, stock valuations hover near record highs -- a warning sign for investors in the past. Is a market meltdown around the corner? No one knows for sure, even Buffett. But if a stock market crash is coming, the legendary investor's playbook says to do one thing right now.

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Buffett's top way to be prepared for a stock market downturn

Has Buffett sold all of the stocks in Berkshire Hathaway's (NYSE:BRKA) (NYSE:BRKB) portfolio in the past to be prepared for a stock market downturn? Nope. He has always been adamant that he doesn't know how the market will perform over the near term.

Buffett's No. 1 step to be ready in the event of a stock market crash is a simple one: He builds a cash stockpile. When stocks decline enough, he has ample dry powder to put to work buying shares of great companies at a discount.

Note, though, that the term "cash stockpile" really refers to any readily available funds, even if they're not in a cash account. For example, Berkshire Hathaway currently has a cash position of roughly $365.5 billion, but it includes cash, cash equivalents, and short-term investments in U.S. Treasury bonds.

Buffett doesn't prefer to hoard a lot of cash. He even once stated, "Cash is always a bad investment." His point was that inflation erodes the buying power of cash over time. However, he also compared cash to oxygen in a CNBC interview earlier this year. Buffett said, "You always need to have it [cash] available, because you do not know what will happen."

No prediction skills required

How does Buffett know when to build cash and when to spend it? One of his most famous quotes is, "Be fearful when others are greedy and be greedy when others are fearful." This principle has guided the investing icon's moves through the years.

Buffett has used a key metric in the past to know when greed is rampant. It's the ratio of total stock market capitalization to gross domestic product (GDP). This valuation metric is known as the Buffett indicator.

In a 2001 Fortune magazine article, Buffett wrote that when this ratio approaches 200%, investors are "playing with fire." The Buffett indicator now stands at an all-time high of 238%. That's a pretty good sign that investors are being greedy.

However, Buffett really doesn't need to look at an overall market valuation metric to boost Berkshire's cash position. The conglomerate will naturally have more cash available when Buffett can't find individual stocks to buy at attractive valuations.

Raise cash, be ready for a crash.

To be sure, the stock market can be richly valued for quite a while before its momentum ends. We saw this happen during the 1990s with the dot-com boom continuing for years. We're also witnessing it now: The Buffett indicator has been above 170% since early 2024.

But the dot-com bubble eventually burst. The current bull market will also end sooner or later. There are plenty of reasons for investors to be concerned, including the ongoing war in Iran, which has the potential to drive inflation higher.

Maybe a stock market crash is on the way; maybe not. Raising cash now will allow investors to be ready just in case. That doesn’t mean you can’t still buy stocks, though. Even Buffett is finding a few good opportunities to deploy capital right now.

Keith Speights has positions in Berkshire Hathaway. The Motley Fool has positions in and recommends Berkshire Hathaway. The Motley Fool has a disclosure policy.