Last week I enjoyed dinner with a group of people, one of which happened to be a hedge fund manager and fellow CFA charterholder. As us finance-types are wont to do, we quickly made our way to a discussion of every investment nerd’s favorite question: what is risk?
Warren Buffett, in his 2014 Berkshire Hathaway annual letter (page 18), shared his views on the topic:
That lesson [that stocks are less risky than cash-equivalent holdings over the long-term] 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.
Buffett is pointing out that over the long-term stocks are an attractive way to grow capital while cash and their equivalents (i.e., treasury bills) do little more than keep pace with inflation, as can be seen in the chart below. He’s obviously correct on this point, investing in stocks has historically been one of the best things you can do to compound your wealth.
Now then, does this mean people should ignore volatility and only own stocks? I’d say no. Buffett aside, most of us don’t live in the long-term; we live in the present and volatility is a risk that must be managed in the present.
So, despite my better judgment, I'm going to a disagree with one of, if not the greatest investor of all time and my new friend, the hedge fund manager with the NYU law degree and Stanford MBA to his credit—in other words, two very bright people.