Warren Buffett's Best Rule for Surviving a Bear Market -- and Why It Works

While stocks keep churning higher and touching all-time highs, investors are becoming increasingly nervous about the bottom falling out.

A weekly poll of investors by the American Association of Individual Investors (AAII) showed the highest bearish sentiment among investors in more than two months. AAII's investor sentiment poll for the week of Aug. 26 found that 44.4% of investors have a bearish outlook, compared with 32.9% who are bullish and 22.6% who are neutral. The bearish view is the highest since June 10, when it was 47.7%.

The negative outlook is likely due to a confluence of factors, including inflation, declining consumer sentiment, and an historically high stock market valuation after an almost four-year bull market.

This is a time when investors are nervous, but it is also a time when investors should be on high alert, according to the Oracle of Omaha, investing legend Warren Buffett.

Warren Buffett. Image source: The Motley Fool.

Be prepared when it rains gold

If the market corrects or spins out into a bear market, categorized as a 20% drop in price from recent highs, Buffett views it as a buying opportunity. As Buffett wrote in Berkshire Hathaway's 2016 annual shareholder letter:

Charlie [Munger, Berkshire's late vice-chairman ] and I have no magic plan to add earnings except to dream big and to be prepared mentally and financially to act fast when opportunities present themselves. Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it's imperative that we rush outdoors carrying washtubs, not teaspoons. And that we will do.

What Buffett is saying is that investors should not fear economic slowdowns and market downturns; rather, they should be on high alert for deals. Bear markets and market downturns are when you'll find great long-term stocks at a discount.

It is an updated version of probably his most famous quote: "Our goal is more modest: we simply attempt to be fearful when others are greedy and to be greedy only when others are fearful," which he penned in the 1986 shareholder letter.

The most "wonderful" time

Buffett, who handed over the reins to Greg Abel at the start of the year, did very little buying in his last few years at the helm during the current bull market.

The last time Buffett rushed outside carrying the washtub was in 2022. During the 2022 bear market, Buffett loaded up on Apple, still his largest holding, Chevron, and Occidental Petroleum, which remain major Berkshire holdings today, plus Ally Financial, to name a few. It all harkens back to that age-old investing adage: Buy low and sell high.

Obviously, we are not in a bear market right now, and those dark skies Buffett warned about may not come for a month, a year, or five years. We just don't know. But the most important thing for investors is to get those washtubs ready for when they do come.

The key, however, is not to just buy a stock because it is cheap. Instead, buy it because it's good, at a lower price because, as Buffett said in the 1989 shareholder letter: "It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price."

Ally is an advertising partner of Motley Fool Money. Dave Kovaleski has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple, Berkshire Hathaway, and Chevron. The Motley Fool recommends Occidental Petroleum. The Motley Fool has a disclosure policy.