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D.Muthukrishnan (Muthu), Certified Financial Planner- Personal Financial Advisor

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Buffett Fifty: Advice to Investors

Posted by Muthu on March 2, 2015

It is 50 years since Buffett has taken over and running Berkshire Hathaway. In last 5 decades, he has generated an absolute return of 18,26,613%. Yes, you read it right. That works out to an annualised return of 21.6%. During the same period, the index, S&P 500 has given an annualised return of 9.9%. So Buffett has outperformed the index by 11.7%.

Here is a small illustration for you to understand what 21.6% can mean to you for next 50 years. If only a fund can deliver similar return for next 50 years, Rs.1 crore invested today would become Rs.17,647 crores in next 50 years. Lucky are those who trusted and invested with Buffett.

Buffett has released his 50th annual letter on Saturday. Please click here to read the same. The entire 43 page letter is a treasure to read and re-read. I’ve given below a small portion from the same which you may find it insightful.

He explains how during 1964 to 2014, while the markets (S&P 500) appreciated by 11,196%; the currency (purchasing power of dollar) depreciated by 87%. He further explains as to why we should own diversified collection of businesses instead of currency denominated bonds for the long run. Please read on:

“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 preceding half-century, a period including the Great Depression and two world wars. Investor 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 decline 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 life time. 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 the failing 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 2100). 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, 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 the 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 investments 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 Investing.

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.” “

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