Warren Buffett: Risk Is 'Inextricably' Tied to Time

Some thoughts from Buffett on the topic of risk and reward

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Nov 11, 2019
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I believe

Warren Buffett (Trades, Portfolio) gave some of his best advice before the financial crisis.

In the decades before the crisis, Buffett's investment skill was no less impressive than it is today. However, because he was still under the radar in some respects, questions asked of him at the Berkshire Hathaway (

BRK.A, Financial) (BRK.B, Financial) annual meeting and in interviews, for example, where a lot more technical and informative -- that's my opinion, anyway.

That's why I like to go through old videos and transcripts of Berkshire's pre-crisis meetings

Warren Buffett on risk and time

In 1994, the world was a very different place than what it is today. The fall of the Berlin Wall a few years before marked the end of the Cold War, and the market had recovered from the problems of the late 1980s. The world wide web was in its infancy, and the seeds of the dot-com bubble were starting to grow.

In 1994, Buffett was just as concerned with the risk of an investment as he is today. Despite all of the changes in the world going on around him, the Oracle of Omaha still believed that over the long-term, stocks would provide much better returns than almost any other asset. He thought that the financial risk of owning stocks was virtually zero over the long term.

At the 1994 Berkshire Hathaway annual meeting of shareholders, one investor asked Buffett to define his view of risk. The CEO of Berkshire responded by declaring that risk is "inextricably wound up in your time horizon for holding an asset."

He went on to add:

"I mean, if your risk is that you're going — if you intend to buy XYZ Corporation at 11:30 this morning and sell it out before the close today, I mean, that is, in our view, that is a very risky transaction. Because we think 50% of the time, you're going to suffer some harm or injury. If you have a time horizon on a business, we think the risk of buying something like Coca-Cola at the price we bought it at a few years ago is essentially, is so close to nil, in terms of our perspective holding period. But if you asked me the risk of buying Coca-Cola this morning and you're going to sell it tomorrow morning, I say that is a very risky transaction."

But as the Oracle of Omaha went on to explain, there is never any guarantee in the financial world of being able to avoid losses. In fact, Buffett stated that "we are perfectly willing to lose money on a given transaction." However, while Berkshire might be "willing" to lose money, that does not mean that the group makes deals were the probability of loss is high. As Buffett explained:

"We are not willing to enter into transactions in which we think the probability of doing a number of mutually independent events, but of a similar type, has an expectancy of loss. And we hope that we are entering into our transactions where our calculations of those probabilities have validity. "

The key to this process is to stay away from deals where Buffett can't "write the equation on them." In other words, if it's too hard to work out the risk of loss, then it is best to stay away.

Investing is all about probability. Every investor will have to suffer winners and losers in their career. However, as Buffett said in 1994, the key to being successful over the long-term is to stick to the companies you know best and invest with a long-term outlook. If you do this, the risk of suffering a loss from these holdings drops significantly.

If you jump into something you don't understand with a short-term time horizon, the risk of suffering a loss jumps substantially.

It's easier to reduce risk when you know how.

Disclosure: The author owns shares in Berkshire Hathaway.

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