Stop Playing Russian Roulette With Your Money

Berkshire will forever remain a financial fortress. In managing, I will make expensive mistakes of  commission and will also miss many opportunities, some of which should have been obvious to me. At times, our stock will tumble as investors flee from equities. But I will never risk getting caught short of cash.

– Warren Buffett (2018 Annual  Letter)

For sometime now, Berkshire Hathaway has been criticized for holding this most cash in the company’s history – a whopping US$111 billion. Until the critics show me their investment track-record, I’m siding with Warren on this one. He goes on to say:

In the years ahead, we hope to move much of our excess liquidity into businesses that Berkshire will permanently own. The immediate prospects for that, however, are not good: Prices are sky-high for businesses possessing decent long-term prospects.

Investors haven’t seen bargain basement prices for a long time now. December did however, provide us with a sneak peek – the market falling 20% peak to trough, officially falling into ‘bear market’ territory (who came up with this magic number anyway?). Alas, it wan’t meant to be, with the market rallying about 15% from it’s lows making it one of the shortest bear markers on record:

Source: Charlie Billelo – Pension Partners

Investors who were waiting for lower prices didn’t see it. Investors who were speculating with their wealth got away with one. The buyers will have their day, as long as they remain patient and disciplined. The speculators will too face their day of reckoning.

Rational people don’t risk what they have and need for what they don’t have and don’t need.

– Warren Buffett

If you’ve been playing Russian roulette – usually win, occasionally die – with your wealth, enjoy the present calm. But understand this, you’re strategy is fundamentally flawed. We will eventually see, and investors will need to contend with a sustained decline in asset prices. When this decline occurs no-one really knows. Whilst we have some harmony in financial markets (if I can call it that), you may want reassess your game plan. Here are 3 tips to consider:

  1. Reassess your tolerance and capacity for risk. How much, and for how long, can you afford to lose money. How would your life be impacted if tomorrow you woke up to find out financial markets had collapsed 10%, and began their treacherous road to falling 60% over a 24 month period? How much of your chip stack have you pushed into the pot? The time to reassess risk is when markets are going up, not down.
  2. Invest with purpose. Why are you making this investment? What is the purpose? How did you arrive to the amount of money you invested? What is the exit strategy? Be clear and specific with your investments. If you can’t answer these questions, you have a flawed game plan.
  3. Diversify. If you’re truly following point number 2, your portfolio should naturally be diversified. If you’re not following point number 2, work on point number 3. Is your portfolio diversified all major asset classes, cash, fixed income, property, shares? Is it diversified within each major asset class – for example, sectors, markets, geographies, currencies? How much cash are you holding for opportunities?

If you haven’t had a chance to read Mr Buffett’s 2018 Annual Letter to shareholders, may I suggest you set aside 10 minutes and download your daily dose of wisdom. You can download it here. It constantly perplexes me why so many investors choose to make the journey of wealth accumulation so difficult for themselves and their families.

I’ll leave you with this passage from Mr Buffett’s 2018 Letter:

Let’s put numbers to that claim: If my $114.75 had been invested in a no-fee S&P 500 index fund, and all dividends had been reinvested, my stake would have grown to be worth (pre-taxes) $606,811 on January 31, 2019 (the latest data available before the printing of this letter). That is a gain of 5,288 for 1. Meanwhile, a $1 million investment by a tax-free institution of that time – say, a pension fund or college endowment – would have grown to about $5.3 billion.

Let me add one additional calculation that I believe will shock you: If that hypothetical institution had paid only 1% of assets annually to various “helpers,” such as investment managers and consultants, its gain would have been cut in half, to $2.65 billion. That’s what happens over 77 years when the 11.8% annual return actually achieved by the S&P 500 is recalculated at a 10.8% rate.

Invest like the best.