Each year, Warren Buffett, the legendary investor and Chairman of Berkshire Hathaway, writes an Annual Letter that contains incredibly valuable financial advice and business wisdom.
As a reader of this letter every year for at least the past 20 years, I found this year’s Annual Report particularly insightful, as it celebrated the 50th Anniversary of Buffett and Charlie Munger taking control of Berkshire Hathaway management.
In addition to Buffett’s regular Annual Letter, both Buffett and Munger share their thoughts on the past 50 years and provide some insights on the next 50 years.
I highly recommend reading the Annual Letter to learn more about investing, business, management and how important emotions, behavior, patience and a positive overall attitude are to your financial success. The link to the Annual Report and Letter follow at the bottom.
Below are what I thought were the most valuable lessons from this year’s Letter, with an emphasis on Buffett’s thoughts about investing, the future of the US and the patience that is required to be a successful long term investor.
The headlines in bold are added (they are not Buffett’s). The text below is from Buffet’s 2014 Letter, with the exception of the first sentence under the Geico heading:
Long-term optimism about the future:
“Charlie and I have always considered a “bet” on ever-rising U.S. prosperity to be very close to a sure thing….In my lifetime alone, real per-capita U.S. output has sextupled. My parents could not have dreamed in 1930 of the world their son would see. Though the preachers of pessimism prattle endlessly about America’s problems, I’ve never seen one who wishes to emigrate…”
Positive about the economy, but there will always be volatility:
The dynamism embedded in our market economy will continue to work its magic. Gains won’t come in a smooth or uninterrupted manner; they never have. And we will regularly grumble about our government. But, most assuredly, America’s best days lie ahead.
The Geico “gecko”
Berkshire owns many insurance companies, including Geico. Buffett commented on the value of the “gecko” as their brand spokesperson: “The gecko, I should add, has one particularly endearing quality – he works without pay. Unlike a human spokesperson, he never gets a swelled head from his fame nor does he have an agent to constantly remind us how valuable he is. I love the little guy.”
Stocks, Diversified Investing and Purchasing Power
Our investment results have been helped by a terrific tailwind. During the 1964-2014 period, the S&P 500 rose from 84 to 2,059, which, with reinvested dividends, generated the overall return of 11,196% … Concurrently, the purchasing power of the dollar declined a staggering 87%. That decrease means that it now takes $1 to buy what could be bought for 13¢ in 1965 (as measured by the Consumer Price Index).
There is an important message for investors in that disparate performance between stocks and dollars. Think back to our 2011 annual report, in which we defined investing as “the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power – after taxes have been paid on nominal gains – in the future.”
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.
Stocks are more Volatile than Cash and Bonds, but Volatility is different than Risk
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.
Lessons of the past 6 years and the virtues of owning a diversified portfolio
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).
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 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…”
Note: The above excerpts are from the 2014 Berkshire Hathaway Annual Report Letter, written by Warren Buffett. The full annual report and letter are available at their website, http://www.berkshirehathaway.com/letters/letters.html. You will see his letters dating back to 1977. Click on 2014 for the current letter.