Warren Buffett said that the best way to minimise risk is to think. Here's what it means
18-Oct-2021 •Dhirendra Kumar
...and then Warren Buffett said, "Yeah, we think the best way to minimize risk is to think." He paused. The pause became longer. People in the audience waited for him to complete the sentence and at some point, they realised that the sentence was finished and laughter rang out. He had made his point: the best way to minimize risk is to think.
This happened in a Berkshire Hathaway annual shareholders' meeting some years ago. Buffett was replying to a question about what he thought of the sophisticated asset-allocation models that Wall Street provided at a great price to investors. The old man went on to explain, "I've got (they say) 60 percent in stocks and 40 percent in bonds, and then they have a big announcement, saying now we're moving it to 65/35, as some strategists or whatever they call them in Wall Street do. I mean, that has to be pure nonsense. 60/40 or 65/30 - it just doesn't make any sense. What you ought to do is ... your default position is always short-term instruments and whenever you see anything intelligent to do, you should do it."
At first, that will sound like really radical advice to you and me. He's essentially saying that you should not have a pre-set asset allocation. Or rather, you should not follow any fancy asset-allocation model that a finance professional is selling. Your default asset allocation should be 100 per cent in short-term instruments, which in India would mean something like a short-duration debt fund. And then, on top of that, 'whenever you see anything intelligent to do, you should do it'. That means that when you see other assets like stocks at a high-enough quality and a good-enough value, you should buy those. However, at all times, you must remember that 'the best way to minimize risk is to think!'
On the face of it, this flies in the face of what any investment advisor or analyst - including me - would say. Surely, every investor must distribute their investments over different asset types and therefore, they must have an asset-allocation model. This is undoubtedly true. However, what Buffett is saying implies something very different - your asset allocation is yours alone. It depends far less on the state of the outside world and far more on your own state. Moreover, there is no precise formula for it.
My idea has always been that there are only three possible equity-vs-debt allocations. These are: (1) lots of equity; (2) lots of fixed income; and (3) A balance of equity and fixed income. That sounds hopelessly vague, does it not? In fact, it has all the precision you need. Practically, I would define it as 25 per cent, 50 per cent and 75 per cent. However, you can adjust it if you think it should be something else. That's the same meaning of the word 'think' that Warren Buffett meant. Someone setting out to start earning, with a very few liabilities in life could aim for high equity. As life goes on and you draw nearer to retirement, or there are some other troubles you foresee, move towards the balance. Then, as the end of your earning life draws nearer, shift to the other side. By all means, adjust it to your own life's circumstances. If you have a good source of earning into your old age, or you have built a large asset base, you could keep investing like a young person. In fact, that would maximise the wealth you leave for your descendants.
Anything that anyone tells you can be no more than a starting point. There are savers who will stay in simple bank products or mutual funds because they do not want to learn the complexities of investing but stock investors, especially the readers of Value Research and Wealth Insight, are not like that. Our job is to provide you with the starting points, along with the tools and information that will help you move towards your financial goals.
This editorial appeared in Wealth Insight October 2021 issue. To read the cover story and other insightful analyses, columns and articles