Warren Buffett On Volatility And Risk

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The Berkshire Hathaway annual letter to shareholders was released this past Saturday. Now, this is somewhat of an event all in itself for capitalists all around the globe. Even if you’re not a shareholder of Berkshire Hathaway Inc. (BRK.B), one looks forward to any dribble or drop of knowledge from the greatest known investor of all time, Warren Buffett.

I’m don’t own any BRK stock, so I’m not a shareholder. And that’s due primarily to the fact that shares do not pay a dividend and thus do not fit my goals/needs/desires. However, that doesn’t mean I’m not a huge fan of all things Warren Buffett. And I say that not just in the business or investing sense, but also in the lifestyle sense.

I’ve read his biography, The Snowball: Warren Buffett and the Business of Life, twice now. And I plan on visiting Omaha in May to attend the annual shareholders’ meeting to see Buffett up close and actually hear him speak in person.

As such, I’m as excited as anyone when it comes to reading the letter. I love to comb through it for any new potential tidbits of wisdom. I haven’t read anything particularly groundbreaking in quite a while from Buffett, but that’s because the guy’s just so consistent in his belief system, which is something I admire and try to emulate to a degree.

However, this letter was groundbreaking in one way: It marks the 50th anniversary of Buffett – through Buffett Partnership Ltd. – taking control of Berkshire Hathaway (then just a struggling textile manufacturer) and slowly turning it into what it is today. An incredible story, no doubt about it.

Whereas a substantial portion of the letter reflects on the past, present, and future of Berkshire via Buffett’s perspective and a supplement from Vice Chairman, Charlie Munger, I’m going to focus today’s article on a particular section of the letter that happens to be more general investment advice that’s as sage as ever.

On page 18 Buffett takes a moment to discuss investing, stocks, risk, and volatility; and how someone with a long time horizon should really be investing:

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.

This is really great stuff here.

It seems, for whatever reason, that volatility is often synonymous with risk for most people. I’ve never viewed it that way. Volatility has never been a proxy for risk, in my view. I’ve never looked at a stock with a low beta (a measure of a stock’s volatility against the broader market) and thought to myself: “Yes, this stock isn’t volatile! It must also be low in risk”. If anything, I bemoan the lack of volatility. As I’ve often said, I view volatility as synonymous with opportunity.

Risk can be difficult to quantify. But when looking at stocks, volatility is about the last place I look to in terms of assessing risk. Fundamentals, competitive advantages, market share, debt, size, regulation, and competitive environments tell me a lot more about risk than volatility does. That’s for certain.

When I think of risk, I think of permanent loss of capital. Risk, to me, is the odds of losing money. That’s risk. When I look at an investment’s prospects, I immediately think of the odds that I’ll somehow permanently lose money (factoring in inflation as well). And that goes not just for ending with less money than I started with, but also opportunity costs. If I could invest in Opportunity X, but Opportunity Y will provide far more returns over the long haul (even if the ride is bumpier), then Opportunity X is technically more risky because I’ll technically be losing money. Thus, cash is risky to me. Putting cash under the mattress is an incredibly risky way to handle your wealth because you’re absolutely guaranteed to lose money over time due to the ravages of inflation. The opportunity costs of cash in comparison to high-quality stocks is enormous. Complacency is expensive.

However, volatility is often (always?) seen as a proxy for risk. Thus, most investors diversify into fixed income to reduce risk because it tends to be a much less volatile asset class. But the real risk there, as Buffett is pointing out, is lost returns. You’re essentially paying for reduced volatility. So while one assumes they might be reducing risk, they’re actually increasing it.

I’ve discussed before that I’m 100% invested in stocks. Other than cash to run my day-to-day life and a little on the side for emergencies, my asset allocation is 100% equities. But that comes with an important caveat: I’m a young, long-term investor. Furthermore, I look forward to volatility. There’s a certain personality that does well with going all-in on stocks. If you don’t have it, admit it and spread yourself out. Because you’ll do more harm than good thinking you can be invested heavily in equities only to doubt yourself at the wrong time, which is something Buffett expounds just after the paragraphs cited above. In addition, be mindful of where you’re at. A 70-year-old living off of the income their portfolio provides is a very different life situation than a 32-year-old asset accumulator.

As I was just mentioning in my recent Freedom Fund update, the lack of volatility over the last couple of years has come at the cost of effectively being able to put fresh capital to work. Thus, anyone who’s actively accumulating assets should certainly welcome volatility on a somewhat regular basis. Unfortunately, volatility doesn’t work like that. It tends to come around when you’re least expecting it and least ready for it.

In the end, stocks – specifically high-quality stocks – is one of the greatest investment classes you’ll find in the entire world. 100+ years of returns will tell you that. Every dollar funneled away from excellent stocks is very likely an opportunity cost. If that opportunity cost is worth reducing volatility for you, then by all means proceed. But that opportunity cost is too large for me. Thus, all of my capital is working extremely hard for me in the form of equity in some of the best businesses in the world. Even better, each one of these businesses is regularly raining cash upon me in the form of dividends. Not only that, but those dividends are growing by virtue of growth in the underlying businesses’ profits. So while it all started off as a drizzle, I can now say with some confidence that it’s turning into a full-fledged thunderstorm. And guess what? I don’t have an umbrella.

What do you think? Was the letter another classic? Do you view volatility as a proxy for risk? 

Thanks for reading.

Photo Credit: DonkeyHotey via Flickr

Note: Affiliate link for Buffett biography included. 

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88 Comments

  1. Hi Jason,

    I just saw that you mentioned that you aren’t a shareholder of BRK, but I thought you mentioned that you’d be making the pilgrimage to Mecca (Omaha?) for the shareholder’s meeting as part of your honeymoon. I thought I had read that you have to be a shareholder to gain admittance–is that not true?

    Anyway, I’m most of the way through the letter myself, and am really enjoying it so far. I like that Buffett speaks about running a business, rather than most other companies which seem to just indicate that “we’ve had our ups and downs, program XYZ is on the rebound, and we’re looking forward to a strong 2015.”

    Charles

  2. Completely agree on the long term prospect of owning high quality companies. I always find it funny when I see an article discussing risk and there’s almost always a component of volatility. Volatility is not risk. Risk is owning a company that doesn’t have a durable advantage whether that be scale, manufacturing process, distribution network, brand recognition… At some point I might consider intermediate term bonds to add to my portfolio but for the time being it just doesn’t make sense and even then it wouldn’t be a large portion of my portfolio, most likely 10% or less. With current interest rates you’re betting that the Federal Reserve has a great grasp on inflation and the ability to control it. It won’t take much to tip the balance one way or the other and people accepting 2% yields on 10 year Treasuries is crazy to me. Yes it’s a store of value but the interest you’re earning isn’t even enough to keep pace with the Fed’s target inflation rate. That’s a real risk. Thanks for your insights on WB’s latest shareholder letter.

  3. I like everything about Buffett. He is so knowledgeable, and yet still takes the time to teach people about investing. The Alice Schroeder book was like a call to action for me – it is so amazing! And when you also get the annual letters, partnership letters, articles on him and from him, and you get this amazing gold nugget of knowledge.

    The thing I like most about Buffett is that he actually “retired” in 1955-1956. The partnership and Berkshire were essentially his way to leverage his thirst for investment knowledge into more money. But the nice thing was that he wanted freedom, which is what many of us strive for.

    Either way, you will have fun at the meeting..Try asking him a question 😉 Good luck!

  4. I just read the letter earlier today and I also found the part you highlighted to be especially good. It’s hard to ignore the day to day, month to month and even year to year fluctuations in the market, but keeping your eyes on building real wealth is much more important. Buffett’s ability to look past the market noise and focus on the underlying long term value of a business, its economic moat and its profitability has made him and his shareholders a great deal of money. I’m a Berkshire shareholder, and while I don’t know what the market will price the shares at in the near term, I’m very confident that my shares will be worth much more 10 or 20 years from now as those underlying businesses continue to grow. And maybe, just maybe, they’ll pay a dividend by then and you can come on board too.

  5. JC,

    I agree. Volatility is an assumed proxy for risk. Why that exactly is, I’m not sure. Human nature I guess. A good portion of successful investing is simply managing your emotions.

    Thanks for dropping by! Hope all is well over there.

    Best wishes.

  6. DGI,

    Yeah, I remember reading about Buffett’s thoughts on how he considered just retiring and what not way back when. But he actually enjoys what he does. In that regard, he’s still technically retired. As I’ve mentioned quite a few times now, you have to spend your time doing something, even if you’re “retired”. So he says he’s tap dancing to work because he enjoys it and it’s not actually “work” to him. He basically does it for free these days. Thus, I consider myself in a very similar and fortunate boat. Though I’m not financially independent yet, I’m basically living my life as if I were a billionaire. Once you’re able to live life without thinking about money and compensation, you’ve essentially won. 🙂

    Thanks for dropping by!

    Best regards.

  7. I think part of the reason that volatility is equated as risk is because as humans we feel like we need to be able to quantify everything. Surely something’s value that can change +/-30% in a given year has to be risky right? I’m just about finished reading Fooled by Randomness by Nicholas Taleb and it’s been an interesting and easy read. I’ve got a few more books lined up but sometime this year I plan on working through Black Swan as well.

  8. Chris,

    Agreed. Buffett’s success is a combination of rare intelligence and an ability to control his emotions. Being able to value businesses reasonably accurately is one thing. But being able to hold true to your convictions through thick and thin is quite another. Do both fairly well and it’s highly likely you’ll end up pretty wealthy over a long period of time.

    BRK shares could go anywhere in the short term, like any other stock. But the odds are good that Geico will be insuring more drivers and BNSF will be transporting more goods when looking out over the long haul. And both will be charging more for their services due to inherent pricing power. Thus, the stock will also very likely do well over a long period of time, since it represents pieces of ownership in those underlying businesses (among others).

    Cheers!

  9. DM,
    I was reading Buffett’s annual letter Sunday, I thought it was a great read on a lazy SoCal rainy morning. I view volatility as an opportunity, as an entry point. I am really bad on timing the market to bottom down so I DCA.

    “If I could invest in Opportunity X, but Opportunity Y will provide far more returns over the long haul (even if the ride is bumpier), then Opportunity X is technically more risky because I’ll technically be losing money”. I never thought of it that way… I would normally put majority of my money to X then some on Y. Great point, I probably need to re-evaluate myself.

    Thanks for another great article.
    FFF

  10. Hi Jason!

    Thanks for the article! I haven’t read the whole letter yet but some of it. The portion you highlighted was very good and I also enjoyed reading about the past of Berkshire and Mr. Buffett. Looking forward to reading your new articles as well!

  11. To me it boils down to this: The less you think with your heart, the better your decisions will be.

    Investing isn’t at all like a relationship. It isn’t supposed to “make you feel good” or conversely “make you feel bad”. Investing is a rational pursuit designed to leverage the success of businesses around you while furthering your financial position. While emotion will always be a part of investing, much like personal finance is in fact personal, it is managing the encroachment of emotion that will allow one to be successful.

    There are days I wish Buffett and I overlapped a decade or two longer than we will. A brilliant man.

  12. Thanks for the insights into Buffett’s latest letter Jason. It is a shame that all these technical models of volatility are taught in finance, and that people learning this stuff really do get a skewed perspective on the real world and what risk really means when investing. Too often we seem to rely on fancy models and calculations, rather than common sense and wisdom. If only this stuff was taught in schools!

  13. Charles,

    You don’t need to be a shareholder to attend the meeting. You have to have credentials (tickets), which are offered to shareholders before the secondary market.

    I agree in regards to how Buffett refers to Berkshire. He refers to it as a collection of great businesses because that’s really what it is. It’s kind of one of those situations where it’s more than the sum of its parts, which is true for a lot of great businesses out there. Really good stuff. 🙂

    Take care!

  14. Sampo,

    The letter was really good. It has all the usual, but this year was a bit different with the reflection components toward the end of the letter.

    Thanks for dropping by!

    Cheers.

  15. W2R,

    Agreed. I was mentioning in another comment that a significant portion of successful investing basically involves managing your emotions. No matter how skilled you are at picking out and valuing great businesses, your emotions will betray you and your success if you can’t manage them appropriately. And I think that’s why people perceive volatility to be a proxy for risk. It’s easier to manage your emotions when things aren’t all over the place.

    I also wish my timeline would have intersected a bit better with Buffett’s, but I suppose it couldn’t be any other way. The only way he could become who he is now was to be born when he was and live as long as he has, and the only way for me to do what I need to do is to start early as a young man and learn from him. Such is life. I am looking forward to actually being in the same room as him come May. Not sure how many more opportunities for that I’ll have.

    Best wishes!

  16. Jason,

    It’s a shame that common sense isn’t, well, more common. 🙂

    But I guess that’s why Buffett is such an enigma. And it’s part of his appeal. He favors a simple approach over complex models, which is something I also prefer (as I was recently writing about). Making a lot of money just doesn’t have to be very complicated.

    Thanks for dropping in!

    Best regards.

  17. Mr. Buffett doesn’t do airline or technology stock because he doesn’t understand them or the prosperity.

    When FB IPO came out, he was asked whether to invest in FB, he said American will not tolerate tracking … privacy probing will eventually fade. And he didn’t understand/like buying into a stock that the owners are actively selling (IPO is all about). 😛

    The man has a lot of wisdoms, in 2008-2009 when everybody were selling, he came out and said he has confident in American, and American company. He trumped the S&P or most hedge funds.

    I’m also interested in his right wing Britt, who does the research for him, also the recent talk that most of the buying and selling now are done by his staff, and not him. Wondering they are using his principle with the recent XOM, and COP selling. Or it’s one of those 2006, 2007, he silently moved into cash position. And when the time came he picked up Goldman Sach, and a bunch of companies at the sell off prices.

  18. Just before reading this post, I read a article about Guo Guangchang. Just “met” him now. Huge fan of Buffett and trying to replicante his Mo. The Article is from Financial Times, and I read it in a Waiting room for doctor appointment. Note sure if it is avaible online. Sorry any mistake, I ‘m testing my new (chinese made) smartphone to write this

  19. Great perspective. I haven’t had the time to read the entire letter yet, that’s on my to-do list. I’ve read a bunch summaries here and there already though.

    I totally agree with you on volatility. When we’re in the accumulating phase, volatility is a welcomed event. It means we can add stocks at a cheaper evaluation. Stock markets have about 6-7% annual return if you hold the securities for a long time, too many people are too concerned about the day to day movement and freak out. Investing with a long term view is extremely important. If you need the money tomorrow or the next few months, you shouldn’t be investing that money in the stock markets.

  20. It was actually great to see Buffet address volatility. Volatility does not equal risk, strait out of the Oracle of Omaha’s mouth himself.

    DM – Your comment “volatility is about the last place I look to in terms of assessing risk” is very interesting to me.

    Only because this is the first place I look, not for risk but for opportunity.

    I sell options and in the options world there are two distinct types of volatility: Historical & Implied. Historical volatility is the type that you and Mr. Buffer are talking about. The actual day to day swings in a stocks price.

    Implied volatility on the other hand is anticipated volatility that effects the price of an option. Price and volatility have an inverse relationship, so during periods of declines it causes fear which inflates premiums on options as people rush to buy portfolio protection. This makes for mouth salivating premiums for option sellers like myself.

    Market declines are in my opinion the most opportunistic.

    I just thought it was interesting that where most people find risk…it is the first place I look for opportunity. It just speaks volumes at how different approaches can be had in the same pursuit of financial reward.

    Cheers!

  21. DM,

    I really enjoy your perspective on viewing volatility as opportunity. This goes right in line with building a dividend growth portfolio and being able to use volatility to the downside as an indicator for entry points, given the particular business is still a sound investment.

    “Short term volatility = long-term opportunity”

    Regards,
    Dividend Odyssey

  22. DM,

    great point to discuss. I see as you volatility as a chance to buy great companies at fair values. On the other hand, risk is for me buying a company you don’t understand and which is just trendy. Personally I try to reduce risk by carefully analyse fundamental stock financials, trying to understand the business model and overall market development. Maybe only for short time stock holders price volatility is similar to risk, because the have to sell their stocks to a definite time (e.g. in retirement with partially sell off of the portfolio).

    Regards

    Marco

  23. FFF,

    I hear you. I have no idea about market timing, which is why I’ve invested just about every single month for years on end now. I just try to pick out attractively valued businesses and then get out of the way. 🙂

    Glad the article was able to perhaps give you some new perspective. We’re all learning together!

    Cheers.

  24. Vivianne,

    Yeah, Weschler and Combs are slowly taking over the investment portfolio. Buffett has said that the larger investments are still his, whereas the smaller positions are those that the other two are handling. That’ll continue on until Todd and Ted are completely running the stock portfolio.

    Gotta have conviction in your beliefs and stick with those convictions through thick and thin. 🙂

    Best regards.

  25. Tawcan,

    Definitely. Gotta have a long-term perspective. Worrying about movements even over the course of a year or two is really just noise. I try to think about the next twenty or thirty years. That’s difficult at times when all you know is the present, but knowing that excellent businesses will return you somewhere around that 7% mark smooths out the bumps for me. 🙂

    Cheers!

  26. Gen Y,

    Right. I also look at volatility as opportunity, which is something I pointed out in the article in bold font. I don’t use options at all, but I do generally look forward to the general swings of the market – more the downs than the ups, though. I could use a downswing right about now. 🙂

    Thanks for dropping by!

    Best wishes.

  27. DO,

    Exactly. The noise of the market is generally transient and short term in nature. Over the long haul, we should do well if we stick to great businesses that pay and grow dividends. 🙂

    Take care.

  28. Marco,

    Analyzing fundamentals is a big step toward understanding what kind of risk you’re taking on. Some are happy with more risk, and some other happy with less. I try to keep the overall risk of my portfolio as low as possible while also maximizing dividend income, growth of income, and total returns. It’s definitely a delicate balance.

    Thanks for stopping by!

    Best wishes.

  29. Sensim,

    I’m not familiar with that company or its stock. However, it’s important to keep in mind that even high-quality dividend growth stocks aren’t immune to big drops, especially if the broader market has such a drop (like it did during the financial crisis). If a drop of 20% or 30% scares you, you probably shouldn’t be in stocks. If Vardia is a great company, that’s an excellent opportunity to buy, as the volatility/opportunity I was talking about is in full display there. Really depends on the company. If it’s a low-quality company, then those who bought are seeing the risk that they should have foresaw materialize.

    Best wishes!

  30. I havent read it yet, but I will read Buffets letter tonight… As far as volatility and risk, I agree 100% with you that the two should not be synonymous. Volatility is was generates returns and give the patient investor cheaper access points to the market.

  31. Hi Jason! I am one who have started to read your blog since last year and it is doubtlessa great reference related to Dividend focusing. Also I take advantage of improving my English reading a topic that I like. Carry on this way! I look forward to hearing back from you about this exciting experience and give us your point of view about this meeting. Thank you for your great contribution and share your knowledge!

    Kind regards,

  32. With stocks there are (at least) two types of risk. Market risk and company risk.

    A short history, small profits, small company, no dividend. That is a lot more company risk than a time tested large business that has withstood thunder and rain, maybe for decades and pays a dividend.

    Many jumped aboard with a large part of their portfolio in this company and forgot all about diversification (according to their blogs). All was fine – until it was not.

    I fully agree that one must prepare for 20-30 or even 50 % portfolio loss during general downturns. This happens a few times in an investing life: the market crashes.

    And as you said, even great companies can fall a lot on their own. That can be a good spot in I buy – if the company is still good.

  33. DY,

    Definitely. For long-term investors, volatility is nothing more than an opportunity. Let’s hope we get such an opportunity sometime this year. 🙂

    Best regards.

  34. Francesc,

    Thanks for following along! Glad to have you aboard for the journey. 🙂

    I’ll definitely share what I can about the meeting. We’re only going to be there for a few days and my camera is old and low quality, but I should be able to put a nice little report together.

    Best of luck on your own journey!

    Cheers.

  35. “Volatility is an assumed proxy for risk. Why that exactly is, I’m not sure.”

    I think it’s based on the assumption capital appreciation is the souce of investment income. If you rely on capital gains for investment income you are completely at the mercy of the market when you need to sell. If you own assets with high price volatility, there’s the risk those assets are sold below value.

    By relying on dividend payments and adopting holding period of forever (i.e. never buying something with the idea of selling it at a later date), you divorce yourself from the “risk” of price volatility.

    Price only matters at two times. When you buy and when you sell. And if you never sell, then once you own something then the price doesn’t matter.

  36. Sensim,

    Absolutely. This article – and Buffett’s assertions – was about market volatility as it relates to risk. I view risk less in terms of market volatility and more in terms of company-specific quantitative and qualitative measures.

    Like I mentioned, I’m not familiar with that company or the stock market over there. So I can’t really comment. But I stick with companies with proven business models that pay me growing dividends because they’re, on average, less risky with better fundamentals, in my view. After all, you can’t pay out a growing dividend for 20 or 30 years without the growing cash flow to support it.

    But even then, one should diversify and average in, as Buffett is recommending (and what I recommend pretty consistently). It’s a shame people bet large on that company over there.

    We had a somewhat similar situation over here with a company called GT Technologies. There were some people betting their life savings on this company, but it went bankrupt not long ago. A real shame. It’s funny how people view risk in terms of market volatility while ignoring the real risk of the company they’re investing in. I’m doing my best to share the knowledge. 🙂

    For further reading on the epic failure of GT Technologies, this forum had an amazing/depressing/shocking discussion that was live through the rise and fall of the stock:

    http://forum.thecontrarianinvestor.com/index.php?threads/gt-advanced-technologies-inc-gtat.69/

    Best regards.

  37. Nicholas,

    Sure, I think that’s part of it, which is why I mentioned the caveat about someone’s point in life changing their perspective. However, even a broad index fund will provide some income component to cushion some of the shock of a broad drop. And you have to take the good with the bad. That same volatility is what should have propelled your wealth to heights it never could have been otherwise. I imagine that someone relying on selling off assets in retirement for income would adopt a strategy that isn’t 100% equities.

    In large part it’s because of not wanting to be a slave to the market’s endless oscillations once I’m no longer accumulating assets that I invest the way I do.

    Thanks for dropping by!

    Best regards.

  38. His letters are always a master class in investing, management, and psychology. I highly recommend everybody buy the Kindle book that combines all the letters from beginning through 2013.

    Volatility is definitely not risk with the right time horizon.

  39. Jason,

    I love the way you take the time to answer every comment even though your comment area is very busy! I hope I can keep up that pace if my blog ever becomes as popular.

    I follow lots of Dividend bloggers. I’m still not entirely certain why there seems to be an aversion to ANY non-dividend payers. Some of them are high quality. And they have options so you can ‘make your own’ dividend with out of the money covered calls if you are that hot for income. BRK-B is a pretty good example here. You could own it pretty safely and create your own 1.5% a year distribution while still capturing the upside. YMMV.

  40. You make some great points in the article. The fact that the stock market goes up over the long term is one reason why I made the choice to invest. I believe that one of the underlying forces that helps propel the markets upwards over the long term is simply inflation. As inflation grows so does the cost of goods and services, and as a result the revenues and EPS of the companies who produce them grow. Inflation has always been around and always will (although quite low at the moment). So as you say there may be temporary volatility (buying opportunities) you can always rely on inflation to work quietly in the background.

  41. Adam,

    Buffett is a rare individual, that’s for sure. Always enjoy his perspective on all things investing and business. Even his reflections on life in general are usually quite enjoyable. 🙂

    Cheers!

  42. FV,

    Conversing with others is really what I enjoy most. It’s very, very time consuming, but I enjoy it even more than writing. And this is all on top of the freelance writing and emails. 🙂

    As far as dividend vs. non-dividend stocks, I think the reasons have been laid out ad nauseam and make a lot of sense. If it didn’t make sense, I wouldn’t invest this way. Creating your own “homemade” dividend might be easy when the market is up, but not so much when it’s down. And I know you have a pretty high SWR over there. Likewise, that works a lot better during bull markets like we’ve experienced lately. It’s far different when stocks are dropping.

    Best regards!

  43. Volatility is a great thing being a long term investor. Case in point, oil and gas stocks recently. If history repeats itself, these companies will continue to make money long into the future despite the recent drop in oil prices. Therefore, buying some of the good ones now could reap even greater rewards in the future.

    Buffett is a great investor to look up to. I especially like the “do something you love to do and you are essentially “retired” for life” I work to invest but I really can’t wait to leave. I’m not in a dream job so that’s why my wife and I continue to invest heavily.

    Thanks for the excerpt from his report. I need to read it sometime.

    ADD

  44. God, I wish Berkshire would pay a dividend. I’ve been salivating over that collection of businesses for months and months. Me passing a Benjamin Moore is like a kid walking down the aisles of Toys R Us: “I want it I want it I WANT IT!!!!!!

    But I’m in the same boat as you, Jason. As great as the company is, the stock just doesn’t do what we want it to do. Not that it underperforms in any manner, but if it doesn’t pay a dividend, then how are we supposed to earn a rising stream of passive income from it? Even Berkshire’s price is tied to some degree to the whims of Mr. Market; so what happens when the time comes to sell Berkshire in order to cash in on all those years of holding and the stock goes down? As wonderful a business Berkshire is, I’ll stick with my dividend payers.

    Many people predict that Berkshire will pay a dividend in 15-20 years and are buying now in order to capitalize on it (expecting a fantastic YOC even if Berkshire pays only a couple percent yield based on its share price at the time). Even Tim McAleenan from the Conservative Income Investor believes that this will happen, and as such made the company his only non-dividend payer. I was curious as to what you thought of this, Jason. Personally, I’d rather just let my money compound in the form of dividends elsewhere for that time (15-20 years is a long time for your money to NOT be returning to you in cash flow), but I will say that I ALMOST did it. I’ll tell you, if I was forced to have one non-dividend payer in my portfolio, it would be Berkshire.

    Anyway, sage advice from the Oracle of Omaha as always. Hope you get to meet him during the convention. Maybe he’ll let you interview him.

  45. ADD,

    I definitely recommend reading the letter. The stuff that relates to Berkshire specifically can easily be avoided if you’re looking to pick up generalized advice and information.

    Buffett’s idea about doing what you love is something I absolutely tried to emulate and I worked incredibly hard to get to this point. I’m really glad that I did so, because I’m living life like a billionaire. If you haven’t already read his biography, it’s a great read.

    Keep working hard over there. You’re buying your freedom one month at a time. 🙂

    Best wishes.

  46. the insurance guy,

    Inflation definitely helps propel high-quality companies with pricing power. Doesn’t work quite the same for some commodity plays and what not, but a healthy dose of inflation is generally good for most stocks, especially those with pricing power. Inflation isn’t going anywhere. If you can’t beat it, join it. 🙂

    Take care.

  47. Joey,

    It’s really hard to say. Buffett is a staunch supporter of the no-dividend policy and specifically mentioned a recent proxy on the policy. It’s funny because almost every single major investment in the stock portfolio is a dividend growth stock. But as long as Buffett is alive, there will be no dividend. After he’s gone it’s hard to say. Really all depends on capital allocation opportunities at the time, I suppose. But it’s anyone’s guess. I generally stay away from speculating on stuff like that, because it’s jut not possible to say.

    15-20 years is a long time. Buying a stock now to possibly capitalize on something that might happen in two decades isn’t a prudent investment decision, in my view. If you’re investing in Berkshire for a possible dividend, I would say why bother when there are almost 700 dividend growth stocks to choose from? That makes no sense. Again, speculation. Now, if you’re investing in Berkshire because you love the business model, it fits your goals, and you think it’s the best opportunity for your capital, that’s a very different story.

    But I get to enjoy Buffett’s wisdom and advice from afar while growing my passive income and getting ever closer to financial independence. That works for me. 🙂

    Cheers!

  48. Katherine,

    Not really. Not in my view, anyway. There’s a lot going into why volatility occurs, some of which can’t be quantified. But volatility is still an opportunity, regardless of the reasons for volatility occurring in the first place.

    Take care!

  49. I skipped ahead to the Page 500 range. Really heartbreaking stuff there. People talking about how their entire 401k, IRAs, and life savings were gone in an instant. But it reaffirms the DGI community’s strategy. I know that I will never be stressing out about Coca-Cola or Procter & Gamble.

  50. I actually think Buffet’s got this a bit wrong (a deplorable statement I know). Volatility is most definitely risk to people who don’t know what they’re doing when investing in the stock market. When someone buys a stock because Jim Cramer or Fortune magazine recommends it, and then it goes down 20% that downside volatility is what causes them to sell. For those people, the volatility is the risk because it too often leads to the permanent loss. For the people out there like DM who have a laser focus on their goals, they turn the table on volatility and the risk for others becomes opportunity for them. Unfortunately, the vast and I mean vast, majority of retail investors fall into the first camp. Having said that, I don’t think for a second the academic who came up with risk = volatility was making this distinction in his mind. I think he probably just needed something convenient like volatility to make his fancy formula work. And it is a real shame this crap is taught in business schools and repeated like it’s investing gospel. Almost every CFP out there follows this line of thinking (because it’s taught in the coursework and everybody else does it so it must be right), so when you hire a “professional” you’re most likely not going to get away from it either.

  51. I really enjoyed your post, Jason. This was the first year I read the shareholder letter and now I’ll have to go backwards because I want more. I’m also currently really enjoying “The Snowball”. There are so many worthy quotes on every page. Thanks for the recommendation!

  52. Randall,

    I think Buffett is separating correlation and causation. It’s not volatility that causes people to sell. If that were the case, everyone (me and Buffett included) would sell. Volatility is just the result a lot of different factors. What people do with that volatility is up to them. However, emotional responses generally cause people to sell. The volatility just sniffs out those who have control of their emotions and those who don’t. Those who respond to the volatility in a logical, pragmatic, and businesslike manner will generally use that volatility to their advantage.

    But I guess, in the end, I disagree with the assertion that he got this wrong. People selling on volatility doesn’t automatically make volatility risky. Not controlling your emotions, however, is risky. Maybe people are risky?

    Cheers!

  53. Ryan,

    Glad you’re reading and enjoying Buffett’s biography. It’s a big book, but an easy read. I like that it really explored all areas of Buffett’s life, both personally and professionally. Really good stuff. 🙂

    Hope all is well over on the West Coast!

    Best regards.

  54. Jason,

    Great post! I downloaded the Berkshire shareholder letter yesterday, but didn’t get around to reading it yet – now I can’t wait.

    Volatility definitely isn’t synonomous to risk, but the problem is that many people can’t handle volatility and thus introduce risk in their portfolio. The risk factor being themselves: “Oh no, gotta sell! I’m down 2% today!” Thinking of investing as believing in a company’s business model rather than putting money into a stock solves that problem for me.

    My portfolio has been down almost 10% since I started, but it’s also been up over 10%. The amount of volatility sometimes surprises me, because I don’t see why the excellent businesses I’m a shareholder of could be worth 20% more now than just three months ago. Weird how it’s not about the business, but rather about the share price and making a quick buck to a lot of folks.

    Best wishes,
    Looking forward to your report on the annual shareholder meeting,
    NMW

  55. Jason,
    if you compare volatility between equities and bonds than low beta will lead you to bonds as an investment which I think is the wrong choice for the long haul.
    But if you take low beta to buy equites than it will lead you to many high quality stocks that dividendgrowthinvestors like.
    So I think low beta = less volatility is a good key figure for selecting dividend stocks.

    Regards
    ZaVodou

  56. I use Joel Greenblatt’s definition of risk: He says there is market risk and non-market risk. Market risk is the whole market going down due to national/global events, recessions, depressions, terror attacks, war.. etc

    Then there is non-market risk, something that adversely affects the earnings of the specific company whether it be lack of demand for a product, factory burning down, accounting scandal.. ect.

    He goes on to explain that you can diversify against non-market risk, you can’t really diversify against market risk. Notice that he never mentions beta or some other academic nonsense. He explains risk in simple real world scenarios as if he is running a business.

    I learned this from his book “The little book that beats the market”

  57. Hi Jason,

    Thanks for getting back to me! Interesting about credentials–I didn’t know! Like you, I’d love to take a trip out there some year while Warren is still running the show. Don’t know if I’ll have the opportunity, but if it comes up…

    My dream vacation is to take the train out there from CA. I know BRK doesn’t do passenger rail, but it’s pretty close, and Marie and I actually got interested in investing/financial independence when we read Atlas Shrugged ~10 years ago or so (influential when you’re a college freshman!). Trains are in our blood 😉

  58. The good thing, Jason, is that you discovered him early. At 32 you still have years to learn from the accumulated wisdom Warren has left. Reading, re-reading, and re-reading again his letters to shareholders is lifetime worth of learning.

    I’m 54, and while I’ve know of Buffett for a long while and thought I knew what he was all about (and agreed with it), it was not until I really started reading the letters that I really realized how much they not just a shareholder letter, but an education about investing and about business.

    About 8 year ago I started dabbling in them.Reading bits and pieces, but skipping larger sections – just kind of looking for nuggets. About 4 years ago I started reading the entire letter as it came out. Last year I took my time to read it slowly as I would a excellent book. This year I’m vowing to read each one that way. In order. Then my favorites again. Then maybe the others again, least they too become favorites.

    Don’t get me wrong, it’s not all about Buffett for me. They are others to learn from. I don’t slavishly follow him. We all need to take our own path. I’m just committing to learning what I can from Warren and I don’t want to miss anything. So I’ll read each one. I suspect it might take multiple times for some things to sink in, and, in my experience, I always pick up more each time I read something again (of course some things aren’t worth it)).

    I hope you have a blast at the meeting. I am a shareholder for about 8 years now, and I have not been. I’m seriously thinking about attending next year. (yea, I know what took me so long to start really reading the letters – live and learn!!)

  59. NMW,

    Yeah, I agree there. It’s kind of like the old “Guns don’t kill people; people kill people” argument. Volatility itself isn’t risky or a problem, it’s what people do in response to volatility. You can use it to your advantage or detriment. Most people choose the latter.

    Hope you enjoy the letter. Even if you’re not a BRK shareholder there’s still a lot of value there. 🙂

    Thanks for dropping by!

    Beset regards.

  60. ZaVodou,

    I think low beta is just a byproduct of being a blue-chip stock. Generally, they’re less speculative investments as a whole, due in large part to the income they provide. And people are more likely to hold them through the ups and the downs of the market, leading then to the low beta. But I would never choose one stock over another because of low beta. Just really depends on how opportunistic you look at volatility as a whole and how you respond to that volatility.

    Thanks for sharing your thoughts!

    Cheers.

  61. frankz,

    Yeah, I agree with that. The risk that Buffett (and I) am talking about here is market risk. And that’s really the kind of volatility that can be advantageous. Non-market risk can be advantageous as well, but it depends on exactly what you’re talking about. Short-term problems for a specific company can be just as much an opportunity as a broader market pullback that brings down all stocks.

    In the end, you have to separate real, fundamental problems from more transient issues when speaking about non-market risk. And that can be difficult. Market risk, however, is great in that you sometimes get the baby with the bathwater treatment, which can lead to fantastic long-term opportunities.

    Take care!

  62. IncomeBucket,

    I hear you there. I reread his biography because I felt like I didn’t really catch all there was to catch the first time around. And sure enough, I felt that I got a lot more from it the second time around. When there’s so much to know and learn, it sometimes takes a couple of times to really let things sink in.

    I haven’t read all of the letters going back decades, but I’ve gone as far back as the mid-90s, I think. Maybe at some point I’ll sit down and read all of them from oldest to newest.

    There’s definitely a lot to learn from Buffett, in all things business, investing, and life. I don’t agree with everything he says and does, but I think that, in large part, he’s done a pretty good job at living the kind of life I’d love to live if I had a crack at it. His personal relationships (with Susan and Astrid) are perhaps a little out there, but I’m not one to judge.

    Thanks for sharing. Let’s hope we can continue to learn from Buffett for many years to come. 🙂

    Take care!

  63. Jason,

    I’m a new reader of your blog and am a big fan of your approach to investing.

    I was wondering why it really matters if the individual stock price of a company goes up if all you really care about is the growth rate of its dividend.

    Let’s say company X’s share price is $50, goes up to $60, then down to $40 over the course of three years. During those same years, the company increases its dividend consistently. If all you’re looking for is dividend security and growth, why does it matter what the actual share price is?

    Thanks

  64. JP,

    Thanks for dropping by! Glad to have you among the readership. 🙂

    Right, so that’s basically what Buffett, this article, and what a lot of my writings are talking about. Unless you plan to buy more of that same stock, price swings are just noise. About the only thing you’re guaranteed in investing in stocks is that the prices will fluctuate. And as I was mentioning about being opportunistic in the face of volatility, your example above would be an opportunity if that stock were to drop from $60 to $40, assuming you want to buy more, have capital, have room in your portfolio, and the long-term fundamentals haven’t changed. Otherwise, you just sit back, collect the dividends, and reinvest where/when you see fit.

    Best wishes!

  65. This is a great discussion by the way…you’re correct of course, the price drop messes with people’s emotions and that gets the regretful reaction not the price movement itself. But it’s the downside volatility that causes the psychological impact in the first place, so to me that’s where the risk is for 99% of investors. I guess we’re going around in circles here, important thing is you’re doing a great job helping people reduce the temptation to sell. It will be interesting to see how much your readership drops (if any) during the next market crash, that will tell you lots about your reader’s emotions.

  66. Thanks for sharing this Jason. I tend to be more of a risk averse investor and the clear distinction between volatility and risk gels well for me.

    They are not the same because of the time horizon of our investment strategy. Some of my stocks fluctuate everyday but it has been performing consistently over the past year.

    And a bonus for us dividend growth investors is that the dividends received actually dampens the ‘perceived fear’ of volatility.

  67. DM,

    Buffett is clearly something I need to add to my reading list… I agree with everything you said and what Warren said. History was one of my 2 degrees I got when I finished up college, and it does bother me when people get or analyze history wrong. In this case most average people do. Most of my friends cannot understand why I would risk my money in the market while they can protect theirs in savings or other types of funds. However, like you both say it is not the riskier of the 2 choices, in fact for 20 to 30 somethings it is the best bet for a future of FI or comfortable retirement.

    Regardless of a person’s goal, this is something that should be taught in schools to everyone as early as high school. People fear the market because they see it is gambling too, not for what it is – being an owner or part owner of quality companies.

    Thanks for the quotes and thoughts,
    Gremlin

  68. Josh,

    Right, and I think what you’re saying there really goes well with what Warren was talking about. If you’re investing for, say, six months, then stocks will be much more risky than cash or fixed income, and that’s because of the nature of the stock market. But for long-term investors, the daily/monthly/yearly volatility smooths out, and those big drops become nothing more than an opportunity to buy more shares.

    Thanks for dropping by!

    Best regards.

  69. Gremlin,

    It’s a shame that most people, especially young people, focus on the daily/weekly volatility, rather than the long-term benefits of being partners in wonderful businesses.

    It reminds me of that quote about people looking at the stock market like a guy walking up a long flight of stairs with a yo-yo in his hand. Most people focus on the yo-yo’s action – up and down – when they should be focusing on the guy walking up the stairs.

    Thanks for your thoughts as well. 🙂

    Best wishes!

  70. Evan,

    I’m with you. I always enjoy reading Buffett’s perspective on all things business, investing, and life. Just so much to learn from the guy. Truly one of a kind. 🙂

    Cheers!

  71. I love volatility. It gets me excited especially when stock market does not do well. I can always add fresh capital from my day job into the market when it is cheap which will pay me more through dividend. Can’t say no to that!

    BSR

  72. Hey DM, your recommendation (Josh Peters) describes his Dividend Approach To Risk vs the Standard Approach to Risk where volatitltiy is the measurement. The Standard Approach To Risk might be useful for all investors who emphazise capital gain!

    According to Peters in his Ultimate Dividend Playbook the top risk with a stock is that the dividend is cut or eliminated.

    As a dividend investor, who tries not to follow Mr Market´s madness, I wholeheartedly agree with this view/approach. It makes sense to me as I do not want to sell my dividend paying stocks as long as dividends flow as planned.

    Best wishes
    Thorsten

    PS: do not understand this XOM move of Buffet either

  73. BSR,

    I’m with you all the way. I don’t have as much firepower as I used to, but I still look forward to volatility. In fact, I may look even more forward to it now that I need all the help I can get. 🙂

    Cheers!

  74. Thorsten,

    Right. That’s basically how I view risk as well. I don’t really look at market risk almost at all. Outside of nuclear war or something, businesses become more and more valuable over time, and stock prices generally follow earnings over long periods of time.

    But a dividend cut is where I attempt to quantify/qualify risk. And that’s why I mentioned company-specific fundamentals and what not. One can’t always feasibly predict a dividend cut, but avoiding low-quality companies is certainly more than half the battle. A dividend cut not only cuts my income, but will also likely be followed by capital losses as well. Better to avoid them altogether. 🙂

    Best wishes!

  75. Hey Jason,

    Fairly new to your site. What are your thoughts on 100% individual stocks as you are invested vs having some or most funds in an S&P 500 Index like VFINX as Warren has mentioned? Is it just a matter of your focused more on dividend income and can get a better yield and thus monthly income going with a portfolio of individual stocks (your not as focused on overall return).

    I’m just curious – I’m in both S&P Index (via 401K – no better options) and individual stocks through my self managed accounts for yield.

    Thanks!

  76. radicalcashflow,

    That’s a good question. However, I’ve answered it ad nauseam across the blog and have also written on the subject. It’s getting to the point to where I can’t viably keep repeating the same answers again. You’re free to use one of the two search bars on the blog which will surely answer your question.

    Cheers!

  77. DM,

    I know you are a fan of Buffett. Me too! Do you ever get the urge to swap any of your AFL stock out for some BRK.B? I know Berkshire may not pay a dividend for 10+ years, but I can’t help wonder what that dividend will look like and if it would be better to get in on the front side. The cash Berkshire generates is incredible.

    The reason I compare it to AFL is that I could talk myself into saying BRK.B covers the insurance allocation in my portfolio vs. my current holding in AFL. AFL is a bit of head-scratcher for me. I bought AFL at a great value and it has done well, but it still seems held back by false currency headwinds. Patience is key, so I’ll probably keep holding AFL and hopefully find fresh capital to buy myself some BRK.B one of these days.

  78. Thanks for your insight on Buffet’s letter. I will read it for sure. I am so close to retirement, less than 15 months now. I have moved all of my investments to interest and dividend yielding stocks, some lower dividend with growth, and some higher dividend with less growth. I try not to look at my portfolio on a daily basis as some swings knock my net worth down 60 to 70 k. I must remember that the dividends keep getting paid, and more often than not, the stock price will rebound. Tough to do. Must be the 25 years of less than stellar stock picking by my financial advisor, and myself too. I invest in a lot less risky, lower beta stocks, but still once in a while some lemon happens. Keeping diversified helps. I will be however financially secure, with company pension, RRSP, TFSA, and dividends all paying me. Thanks for your blog, great work, keeps me level headed.

  79. NRG,

    Sounds like you’re in a great spot over there. Pensions are certainly less and less common here in the US. Having access to funds like that certainly helps stabilize your income.

    Stocks go up. Stocks go down. Over the long haul, they generally go up far more than they go down. More importantly, dividends are a direct result of underlying business operations. Those operations oscillate a lot less than the stock market, which is why it’s such an attractive source of income.

    Keep it up. And enjoy the countdown over there. 15 months isn’t long at all. 🙂

    Best wishes!

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