One investing resource that has had the maximum impact on the way I look at this entre field is Warren Buffett’s letters to shareholders.
Each year, toward the end of February, I look forward to the release of Buffett’s annual letter, which is way different from the miserable letters to shareholders that you’ll read in 99% of annual reports.
For as long as he has been writing these letters, Buffett has used them as a tool to share more information with his investors.
These letters are part information update, part investment lesson. He’s quick to admit his mistakes and quick to praise his managers that have succeeded throughout the year.
He also takes great care to share his thoughts on investing.
In that vein, I keenly read an abstract of Buffett’s upcoming letter to shareholders, which was recently published by Fortune magazine.
Here are some extracts from the letter that you may find beneficial.
Investing is often described as the process of laying out money now in the expectation of receiving more money in the future. At Berkshire Hathaway (Buffett’s company) we take a more demanding approach, defining 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. More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date.
This is exactly what Safal Niveshak has been shouting out loudly from its perch all these months.
Saving and investing money regularly, and then seeing the power of compounding take it to greater levels, is what helps people achieve their financial goals.
So whether you want to accumulate money for your daughter’s education and wedding, a foreign holiday, your parents’ medical costs, and your own retirement, you must save and invest ‘now’…and continue to do it for the next few years.
The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability — the reasoned probability — of that investment causing its owner a loss of purchasing power over his contemplated holding period. 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. And as we will see, a nonfluctuating asset can be laden with risk.
It is foolhardy to try to reduce risk to a single ﬁgure, like the ‘beta’. Instead, the real risk of holding any stock (or for that matter, any investment) is only the ‘permanent loss of capital’ – or a complete loss of your purchasing power.
A permanent loss of capital occurs when a stock goes down because of worsening business operations and stays down for a very long time or even forever. For example, if a company goes bankrupt, or its earnings power drops permanently, then shareholder value will also become permanently diminished.
The two simple rules you can follow to reduce your risk – permanent loss of capital – are…
- Know what you are getting into: You must know clearly why you are buying a stock or any investment instead of buying it just because someone advised you to do that. Investing on a free tip you’ve received from someone else is a sure shot way to lose it all. And you won’t know what struck you, as you never knew what you were getting into.
- Avoid leverage: Never borrow and invest (or speculate). Leverage (borrowing) magnifies your losses, and can make temporary setback permanent.
On ‘Unsafe’ Bonds
Most of these currency-based investments are thought of as “safe.” In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge. Over the past century these instruments have destroyed the purchasing power of investors in many countries, even as these holders continued to receive timely payments of interest and principal. This ugly result, moreover, will forever recur.
Buffett’s reasoning is simple here. How can an asset that earns a post-tax return of 5-6% be considered “safe” when inflation is running at 9-10%?
That’s slow and steady destruction of capital!
Gold…currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.
What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As “bandwagon” investors join any party, they create their own truth — for a while.
Now this is what I wrote on the Facebook Wall of a friend and a reader of The Safal Niveshak Post on his concern about owning some gold in his portfolio…
“Gold is money, and it is the only real currency in the world of fake paper currencies. Gold returns well when all other returns are fake (what we are going to see for some years to come)! Of course, speculation is bad, but there’s a greater amount of speculation in assets other than gold. So have gold, but keep it under 10% of your portfolio.”
I agree with Buffett that Gold does not have any intrinsic value of its own and will not earn you anything till the time you sell it. I also agree that you will earn money on Gold only when someone is ready to pay you a higher price in the future, which is uncertain.
That is the reason I always suggest people to have just ‘little’ amount of Gold in their portfolio – say around 5-10% of total portfolio size.
Apart from being an investment, Gold holds an emotional appeal for us Indians and you will rarely sell your Gold. Instead you will be happy to gift it to your daughter or daughter-in-law in the future.
So to ensure that you do not have to buy expensive Gold in the future, it makes sense to buy some now.
As far as Gold prices are concerned, I believe these will rise given the amount of deterioration we will see in paper currencies going forward.
This is highly certain given the way central bankers worldwide are printing currencies. This will lead to a consistent decline in the value of paper currencies (simple economics – price falls when supply rises). And Gold rises when paper currencies fall. As simple as that!
But whatever it is, I suggest you don’t speculate in Gold. Instead, invest in Gold just because you might need it in the future, not because someone else is buying…and not at all because the price ‘will’ rise.
My own preference is…investment in productive assets, whether businesses, farms, or real estate. Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment. Farms, real estate, and many businesses such as Coca-Cola (KO), IBM (IBM), and our own See’s Candy meet that double-barreled test. Certain other companies — think of our regulated utilities, for example — fail it because inflation places heavy capital requirements on them. To earn more, their owners must invest more. Even so, these investments will remain superior to nonproductive or currency-based assets.
Even I hold a preference for stocks, and for the reasons Buffett mentions above.
I also believe that an investor having a 10-15 year investment horizon in front of him, must have a large portion of his assets in stocks (or equity mutual funds).
But the idea here is to buy and hold not just any stocks (like flavors of the month!), but companies that have great, sustainable businesses.
In Buffett’s words, invest in companies that…
- Have the power to raise prices during inflationary times, and
- Require a minimum of new capital investment
But can you find such companies in India?
My answer is – Yes! There are several great businesses in India that must be part of the long term portfolio of every investor, but only at the right price.
I’ll be covering such businesses as part of the Safal Niveshak StockTalk initiative.
But the underlying idea for you is to stay away from stock markets if you are looking at it from a short term perspective.
There are great risks in being a short-term player in stocks. But risks reduce considerably if you invest for the long term.
Over the long term, I believe that stocks will prove to be the runaway winners among the three we’ve examined above – stocks, bonds, and gold.
More importantly, stocks will be by far the safest.
You see, ignoring Buffett’s words in the past has proved expensive for investors. So he’ll be brave who does so now!
Sachin Ghugare says
I am a follower of the beliliefs pf Warren Buffet, Graham, Philip Fisher, Peter Lynch. I feel as mr. fisher says correctly if the job has been correctly done when a common stock is purchased, the time to sell it is -almost never.( From Common Stocks and Uncommon Profits by Philip Fisher).
Further, as clearly mentioned by Buffet in his essays we need to purchase businesses which are “inevitables” (viz. Coca Cola, Gillete). Is it possible for a potential competitor to displace these giants which has more than 50% market share of their industries?
Vishal Khandelwal says
Hi Sachin, I’m not sure in what respect you have asked your question. But yes, as you rightly mentioned, these are the few among the many strong businesses that Buffett holds, and which are the leading names in their respective industries. Competitors have tried for years to displace these guys, but have not been able to do so. This is one quality you must look for into companies you buy even in India.
Vishal you are right about having a emotion when it comes to gold and we hold it and never sell, but thats only in the case of physical gold.
If i invest in Gold even 10% of folio i wont be holding it physically and hence wont have a emotion attached to it, Also as you say “stocks will be by far the safest” which means to me that although you can buy gold but you still believe that Stock is better, so why diversify?
Vishal Khandelwal says
Hi Vikrant…Yes, ETF is a good way to own gold, but a majority of Indians still love the physical stuff and that’s where the emotions come into picture.
As for your second point…
1. ‘Concentration’ helps your grow you money over the long term….so concentrate in stocks
2. ‘Diversification’ helps your protect your money…so diversify across a few asset classes (like gold).
Buying ETF is another way to speculate on the price of gold. You may lose money in the short term or you may lose a lot in the long term (remember even ETF’s impose 1% pa as mgmt charges).
Your reason for buying gold should be pure ‘preservation’ of purchasing power. Purchasing power that withstands major events such as sudden currency devaluations/invalidations, political instability, systemic collapse, etc. Since these events occur with rare possibility, hence the ‘small’ quantity and not more.
There is no better way to hold gold than pure physical, preferably bars and coins of 99.9% purity.
Anything else, and you are as exposed to these risks as the guy holding shares, bonds, ETFs, Mutual Funds, or even raw cash.