There is more meat than usual in Warren Buffett’s annual letter to shareholders, out today, including reflections by both Buffett and Charlie Munger on the fifty year history of their involvement in Berkshire Hathaway, and why it has been such an exceptional success. If you are so minded, you can read this well-known story as an extended indictment of short termism in both corporate boardrooms and the marble halls of investment bankers (especially the latter). Both Buffett and Munger claim that their unique corporate model will enable Berkshire the company to outlive their personal involvement for many years to come, although I suspect history may not be quite so forgiving.
There is also, as always, some further sound and familiar advice to investors. Buffett notes that the value of shares in Berkshire Hathaway has grown by more than 11,000 per cent in the past fifty years while the value of $1 has depreciated by 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 oranother 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”.
He adds that investors can also make their investments riskier by the way they behave: “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). 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”.
All true of course, but worth repeating from time to time, especially after six years of an equity bull market which has frequently confounded the fears of professional gloomsters. Buffett notes that shares in Berkshire Hathaway have fallen by 50% on at least three occasions, during extreme bear markets. But does that make them a risky investment? The exceptional long term track record of Berkshire Hathaway, which is the best of any listed company or fund manager over the past 30 years, tells you what a bizarre question that is. This year’s shareholder’s letter can be found here.
Jonathan Davis 