In his annual letter for the year,
Warren Buffett explains why mistaking volatility for risk prevents savers from
realising that equity is the best investment
It's that time of the year again
when Warren Buffett's fan eagerly wait for the pearls of wisdom that the master
drops. Around this time of the year, Buffett writes his annual letter to the
shareholders of his holding company, Berkshire Hathaway. Besides writing about
the companies' performance, the doyen of equity investors always writes
entertainingly about a range of business and financial issues.
While those who were looking at his
letter for a revelation of who would run Berkshire after him were disappointed,
those awaiting a package of wit and wisdom about business and investing were
not.
One of the most interesting passages
in the new letter is about the superiority of equity investing over the long
term. Here's what Buffett says:
Our investment results have been
helped by a terrific tailwind. During the 1964-2014 period, the S&P 500
rose from 84 to 2,059, which, with reinvested dividends, generated the overall
return of 11,196% ... Concurrently, the purchasing power of the dollar declined
a staggering 87%...
The unconventional, but inescapable,
conclusion to be drawn from the past fifty years is that it has been far safer
to invest in a diversified collection of American businesses than to invest in
securities - Treasuries, for example - whose values have been tied to American
currency. That was also true in the preceding half-century, a period including
the Great Depression and two world wars. Investors should heed this history. To
one degree or another it is almost certain to be repeated during the next
century.
Stock prices will always be far more
volatile than cash-equivalent holdings. Over the long term, however,
currency-denominated instruments are riskier investments - far riskier
investments - than widely-diversified stock portfolios that are bought over
time ... That lesson has not customarily been taught in business schools, where
volatility is almost universally used as a proxy for risk. Though this assumption
makes for easy teaching, it is dead wrong: Volatility is far from synonymous
with risk.
It is true, of course, that owning
equities for a day or a week or a year is far riskier (in both nominal and
purchasing-power terms) than leaving funds in cash-equivalents. For the great
majority of investors, however, who can - and should - invest with a
multi-decade horizon, quotational declines are unimportant. Their focus should
remain fixed on attaining significant gains in purchasing power over their
investing lifetime. For them, a diversified equity portfolio, bought over time,
will prove far less risky than dollar-based securities... If the investor,
instead, fears price volatility, erroneously viewing it as a measure of risk,
he may, ironically, end up doing some very risky things.
Investors, of course, can, by their
own behavior, make stock ownership highly risky. And many do. Active trading,
attempts to 'time' market movements, inadequate diversification and the use of
borrowed money can destroy the decent returns that a life-long owner of
equities would otherwise enjoy.'
What Buffett says here is a simple
message, and yet that has proven really, really hard to understand. In fact,
it's far less understood in India than in the US. The idea that the volatility
is a measure of risk only with reference to a particular time frame is unknown
outside a small proportion of investors. We accept without question that equity
is riskier than fixed income investments. Some of us qualify this a bit, others
equate equity with gambling. In India, we have an investing environment where
real (inflation-adjusted) returns from fixed income are tiny, and real return
from equity have been huge. A general attitude that equity is unacceptably risky
except for dabbling by rich punters does lasting damage to the investing
portfolios of most Indians.
No comments:
Post a Comment