...the sage of Omaha as he is known and as you probably know - Warren Buffet. This comes from his annual letter to shareholders in his company, Berkshire Hathaway, the latest of which was published this weekend. There is quite a lot in it and I attach a copy at the end of this post if you want to read it in more detail. However, one section which I thought provided the sound advice dealt with returns from investing in equities and peoples perceptions of risk. It was so good I think it is worth highlighting verbatim.
Extract from Berkshire Hathaway Shareholder letter 2014:
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% shown on page 2.
Concurrently, the purchasing power of the dollar declined a staggering 87%. That decrease means that it now takes
$1 to buy what could be bought for 13¢ in 1965 (as measured by the Consumer Price Index).
There is an important message for investors in that disparate performance between stocks and dollars.
Think back to our 2011 annual report, in which we defined investing as “the transfer to others of purchasing power
now with the reasoned expectation of receiving more purchasing power – after taxes have been paid on nominal
gains – in the future.”
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 and that are owned in a manner invoking only token fees and commissions. That
lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for
risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from
synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.
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. That is relevant to certain investors – say,
investment banks – whose viability can be threatened by declines in asset prices and which might be forced to sell
securities during depressed markets. Additionally, any party that might have meaningful near-term needs for funds
should keep appropriate sums in Treasuries or insured bank deposits.
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. Recall, if you will, the pundits who six years ago bemoaned falling
stock prices and advised investing in “safe” Treasury bills or bank certificates of deposit. People who heeded this
sermon are now earning a pittance on sums they had previously expected would finance a pleasant retirement. (The
S&P 500 was then below 700; now it is about 2,100.) If not for their fear of meaningless price volatility, these
investors could have assured themselves of a good income for life by simply buying a very low-cost index fund
whose dividends would trend upward over the years and whose principal would grow as well (with many ups and
downs, to be sure).
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, the payment of high and unnecessary fees
to managers and advisors, and the use of borrowed money can destroy the decent returns that a life-long owner of
equities would otherwise enjoy. Indeed, borrowed money has no place in the investor’s tool kit: Anything can
happen anytime in markets. And no advisor, economist, or TV commentator – and definitely not Charlie nor I – can
tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet.
The commission of the investment sins listed above is not limited to “the little guy.” Huge institutional
investors, viewed as a group, have long underperformed the unsophisticated index-fund investor who simply sits
tight for decades. A major reason has been fees: Many institutions pay substantial sums to consultants who, in turn,
recommend high-fee managers. And that is a fool’s game.
There are a few investment managers, of course, who are very good – though in the short run, it’s difficult
to determine whether a great record is due to luck or talent. Most advisors, however, are far better at generating high
fees than they are at generating high returns. In truth, their core competence is salesmanship. Rather than listen to
their siren songs, investors – large and small – should instead read Jack Bogle’s The Little Book of Common Sense
Decades ago, Ben Graham pinpointed the blame for investment failure, using a quote from Shakespeare:
“The fault, dear Brutus, is not in our stars, but in ourselves.”
Summary & Conclusion
So some great advice there about the longer term benefits of owning a diversified share portfolio to protect your income and capital from the ravages of inflation over time. However to do this you need to be prepared to accept and embrace some extra volatility in your capital. He also talks about a portfolio acquired over time and owned in a manner which incurs only token fees and commissions. This should be the essence of a DIY portfolio and is certainly one I subscribe to along with utilizing tax free wrappers wherever possible to maximize your after tax returns.
I am fortunate in having the time, knowledge and inclination to devote to this and thereby save myself fees and commissions that I might otherwise pay to professionals to manage my money. For others who are perhaps time poor or don't have the inclination to devote the necessary time to running their own portfolio then Warren Buffet's advice is equally clear that you should probably use index funds to get your exposure so as to keep you costs and time commitment to a minimum. Setting up regular payments so you can automate the savings process before you spend the money would also seem to be a good way to stick with the programme through thick and thin.
Also if you are early in your investing journey then you should be hoping for more falls and bear markets so you can get the chance to accumulate more investments at cheaper valuations.