Warren Buffett’s annual letter to Berkshire Hathaway’s shareholders is well known for its pithy and often poignant commentary and this year’s letter is no exception. Tucked between detailed commentary of his many businesses and important information for attendees of the upcoming May 5 annual meeting in Omaha are three pages of analysis that all investors would find beneficial. The title of this section is “The Basic Choices for Investors and the One We Strongly Prefer.”
Mr. Buffett starts this section with the generally accepted definition of investing as the process of laying out money now in the expectation of receiving more money in the future. At Berkshire, they take a more demanding approach, defining investing as “forgoing consumption now in order to have the ability to consume more at a later date, net of taxes and inflation.” Notice the emphasis on consumption is in terms of purchasing power rather than money per se, because inflation is important element in the equation.
He goes on to state the “riskiness of an investment in not measured by market volatility (beta), but by the reasoned probability of an investment causing its owner a loss of purchasing-power over the contemplated holding period.” His point is that assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period.
This emphasis on expected holding period is a key to investing well and is the basis of Bolen Dodson & Associates “Goals-based Investing” approach. You need cash for spending. Fixed income is best used for spending over the next few years. Bonds are not very volatile, but they do not produce returns net of taxes much if at all in excess of inflation either.
Equities are meant for longer term goals of 5-7+ years and beyond. Equity investments are volatile over the shorter term, but are quite predictable over the longer term. Knowing when you plan on using the funds is an important element to successfully investing in equities. Being afraid of short term volatility is a recipe for failure.
In a subsequent blog, I’ll summarize Buffett’s investment choices and his preference. One guess on what he prefers.