If Stocks Tumble This Winter, History Says Investors Who Make This 1 Move Come Out Ahead

Winter is coming. But is a stock market winter coming? No one knows for sure.

What we do know, though, is that the S&P 500 (SNPINDEX:^GSPC) Shiller CAPE (cyclically adjusted price-to-earnings) ratio is near its highest level since the dot-com bubble peak in early 2000.

We know that the Buffett indicator (the ratio of total stock market capitalization to U.S. GDP) is at its highest level ever -- and well above the level that Buffett warned investors were "playing with fire."

And we know the odds are high that the Federal Reserve will again raise interest rates due to stubbornly high inflation.

With all of this in mind, stocks could very well tumble this winter. If they do, history says that investors who make one move come out ahead.

Image source: Getty Images. Image source: Getty Images.

The move that works historically

This move is best known by three words familiar to most investors: "Buy the dip." Warren Buffett famously summarized the underlying premise in 13 words: "Be fearful when others are greedy, and be greedy when others are fearful."

Buying the dip and being greedy when others are fearful has worked exceptionally well in the past. Since 1950, the S&P 500 has had 38 corrections (defined as a 10% or more decline from the previous high). Guess how many times the index has bounced back to set new record highs. Pat yourself on the back if you answered 38.

Buffett practiced what he preached during the 2008 financial crisis. In an opinion article for The New York Times published as the stock market was tanking in October of that year, he acknowledged the factors that were creating anxiety. Buffett then revealed what he was doing in response: "I've been buying American stocks."

The legendary investor was referring to what he was doing personally. However, his Berkshire Hathaway (NYSE:BRKA) (NYSE:BRKB) was also loading up on U.S. stocks back then, including investing in Goldman Sachs (NYSE:GS), Johnson & Johnson (NYSE:JNJ), UnitedHealth Group (NYSE:UNH), and Wells Fargo (NYSE:WFC). Each stock has quintupled or more since.

Applying the approach in today's market

Should investors today buy every stock that falls if the market experiences a downturn this winter? Nope. Buying on the dip doesn't mean buying everything on the dip.

Applying the approach that worked so well historically, therefore, requires using good judgment about what to buy. The smartest strategy is to buy the stocks of companies with strong moats, pricing power, financial stability, and solid long-term growth prospects.

Unsurprisingly, those are exactly the kinds of stocks that Buffett has always preferred. If you look back at the stocks Berkshire scooped up during periods of market uncertainty, many of them will check off each of those boxes.

But Buffett doesn't believe that most investors should bother with buying individual stocks. Why? He knows they don't spend enough time to understand the underlying businesses well enough to accurately predict earnings growth. The "Oracle of Omaha" thinks that many investors would be better off buying low-cost S&P 500 index funds.

Three critical ingredients

This historically successful approach requires three critical ingredients.

The first is one investors should begin getting immediately if they don't have it already -- cash. Without sufficient cash, you won't be able to buy on the dip. Buffett, by the way, amassed a huge cash stockpile for Berkshire Hathaway before stepping down as CEO at the end of 2025.

The second ingredient is a list of high-quality, attractively valued stocks to buy. Importantly, you can't manufacture this list out of thin air. Sometimes, there aren't many stocks that fit the bill. During a significant market sell-off, though, plenty of opportunities should be available.

The third ingredient is the hardest one. Investors must have the discipline to buy stocks or funds even when it's scary to do so. Don't underestimate the difficulty of being greedy when others are fearful.

Importantly, these three ingredients don't mean that you have to be able to predict what the stock market will do. Even Buffett has repeatedly insisted through the years that he doesn't know how stocks will perform over the near term. However, he has always understood that stocks tend to rise over the long term.

Buying on dips has been a winning strategy for the multi-billionaire. It can be a winner for other investors, too.

Wells Fargo is an advertising partner of Motley Fool Money. Keith Speights has positions in Berkshire Hathaway. The Motley Fool has positions in and recommends Berkshire Hathaway and Goldman Sachs Group. The Motley Fool recommends Johnson & Johnson and UnitedHealth Group. The Motley Fool has a disclosure policy.