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The stock market has been soaring over the last two years, with the S&P 500 (SNPINDEX: ^GSPC) surging by more than 65%, as of this writing, since it bottomed out in October 2022. The tech-heavy Nasdaq (NASDAQINDEX: ^IXIC) has fared even better, up by more than 85% since December 2022.
Now more than ever, though, it's essential to choose your investments wisely. The market can't keep climbing forever, and a downturn will hit sooner or later. When that happens, not all stocks will have the strength to bounce back.
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While there's no single correct way that everyone should be investing, there are some guidelines that can better protect your portfolio when the next bear market inevitably strikes. And there's one simple piece of advice from billionaire investor Warren Buffett that could make or break your investments.
The key to choosing the right stocks
In Berkshire Hathaway's 2021 letter to shareholders, Warren Buffett outlined how he and then-business partner Charlie Munger determined where to invest.
"[O]ur goal is to have meaningful investments in businesses with both durable economic advantages and a first-class CEO," he writes.
Please note particularly that we own stocks based upon our expectations about their long-term business performance and not because we view them as vehicles for timely market moves. That point is crucial: Charlie and I are not stock-pickers; we are business-pickers."
At its core, this piece of advice is incredibly simple: Invest in strong companies. But there's a key difference between buying stocks and buying businesses, and if you mistakenly invest in the wrong places, it could spell disaster for your portfolio.
The most dangerous part of the stock market right now
The stock market has been thriving in recent years, and it hasn't been particularly difficult to earn positive returns no matter where you invest. But that doesn't necessarily mean that all stocks -- even those that have seen their prices surge lately -- are strong investments.
Sometimes, during periods of prosperity, the market can get swept up in a wave of optimism. That isn't always a bad thing, but it does mean that shaky stocks can skyrocket in price when investors buy into their hype.
If the companies behind those stocks don't have the fundamentals to match their surging price, though, they'll likely face a steep correction down the road. In severe cases, those stocks may not be able to bounce back from a downturn at all. While these investments may look promising now, they can wreak havoc on your portfolio during the next wave of volatility.