Dont conflate volatility and risk

While almost universally used as a proxy for risk, volatility is “far from synonymous with risk,” says Warren Buffett, Berkshire Hathaway chairman.

Dont conflate volatility and risk


Writing in the group’s latest annual shareholder letter, Buffett agrees that owning equities for a day or a week or a year is far riskier than leaving funds in cash-equivalents.

And, he admits, such a consideration is relevant to certain investors, for example, investment banks – whose viability “can be threatened by declines in asset prices and which might be forced to sell securities during depressed markets”.

But, he said: “For the great majority of investors, 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.”

However, he added: “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.”

As proof of this, Buffett points to the “unescapable” conclusion to be drawn from the last fifty years 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.”
points to the importance of heeding this history, especially as it was also two in the preceding half-century, as it is almost likely to be repeated to one degree or another over the next 100 years.

According to Buffett, during the 1964-2014 period, the S&P 500 rose from 84 to 2,059, which, with reinvested dividends, an overall return of 11,196% . At the same time, the purchasing power of the dollar declined a staggering 87%.

“Stock prices will always be far more volatile than cash-equivalent holdings,” Buffett said, but added: 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.”