Risk is not volatility. Buffett understands the limits of textbook models of the world. One of the more dangerous concepts in modern finance is the idea that risk is synonymous with volatility. As Buffett notes:
“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.”
Risk is the potential that we won’t meet our financial goals. And for most investors that means protecting against purchasing power loss and the risk of permanent loss. Focusing on risk as volatility often leads investors into an unbalanced perspective where why they actually believe they can take far more risk than is appropriate simply because stocks tend to be skewed towards positive returns over the long-term. But this totally ignores the fact that most investors also desire balance between generating high returns and creating stability in their savings. Misunderstanding risk is often the biggest mistake we make in the process of portfolio construction.
Stop paying high fees. Buffett rightly calls out the high fees that are often so unfriendly to investors. I’ve noted on several occasions how much a 1% recurring fee will hurt total returns over the long-term. But we can do even better than that. A smart portfolio can be built with a fee structure that is well below 1%. Chasing returns in exchange for high fees is what Buffett calls a “fool’s game”:
“The commission of the investment 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.”
Collies are the best dogs. As the proud owner of a Border Collie/Aussie Shepherd mix, I can appreciate Buffett’s comment on collies:
“Charlie and I frequently get approached about acquisitions that don’t come close to meeting our tests: We’ve found that if you advertise an interest in buying collies, a lot of people will call hoping to sell you their cocker spaniels.”
Buffett has stated in the past that he prefers to surround himself with people who are smarter than himself. This is as true with people as it is with dogs. My collie is one of the many women I live with who regularly outsmarts me, but more importantly, teaches me consistently on how best to live my life.
We are our biggest enemy. The biggest mistakes we make in the investment world are often due to the fact that we try to make too many decisions. We are prone to mistakes because we are prone to be biased. When you understand your flaws you can prepare your portfolio against its biggest enemy – ourselves:
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.”
Learn from your mistakes and never stop learning. This year’s letter was filled with life lessons. I always say that we can never stop learning in this world. And the best lessons often come from understanding our mistakes. A mistake is only a mistake if you don’t learn from it. Never stop learning. And never be afraid to make mistakes so long as they turn into good lessons.
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