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Commentary

Buffet on risking what you shouldn't

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Warren Buffet makes an incredibly interesting speech in Florida – a 1.5 hour video courtesy Harshit – . A snippet about his thought on Long Term Capital, a Hedge Fund that went bust in 1998, and required the Government to rescue it:

..To make money they [Long term capital] didn’t have and didn’t need, they risked what they did have and did need. And that’s foolish. If you risk something that is important to you for something that is unimportant to you, it just doesn’t make any sense. I don’t care whether the odds are a 100 to 1 that you succeed or a 1000 to 1 that you succeed. If you hand me a gun with a thousand chambers, a million chambers in it, and there’s a bullet in one chamber and you said “Put it up your temple, how much do you want to be paid to pull it once?” I’m not going to pull it. You can name any sum you want. Because it doesn’t do anything for me on the upside, and I think the downside’s fairly clear.

Most people I know would choose to bet big with money they really need – having a loan to pay, or fees or other such stuff. The “skin-in-the-game” or “no pain no gain” argument makes people believe that unless they can feel the pain, they will not make big gains. So they risk what they shouldn’t – their retirement money, their pensions, their savings – to buy that elusive stock which will double in a month. And inevitably, it does not.
This is the equivalent of being told – here’s a gun with twenty four chambers of which twenty chambers have bullets, and I’ll give you double of your bet if you pull the trigger. Very sadly, people choose to pull the trigger for the sake of a little bit more.
Here’s the video, if you have the time:

  • osgeek says:

    >Yes, there are stories of people gone bankrupt when they invest like that. I made a similar point after reading a book, “Many investors have realized the alluring trap of frequent trading and using debt to buy stocks. People have gone bankrupt when they borrow to trade.”
    Here was the post

  • Vercingetorix says:

    >Hi Deepak,

    I read your content on VentureWoods about your idea for online testing for CAT/GMAT etc.

    I am working on a similar idea, and would be very much interested in finding out what went wrong.

    You can mail me at sudhanshuraheja @ gmail.com, or via my blog.

    Looking forward to your reply.

    Cheers

  • Anonymous says:

    >Not everyone can be as lucky as Buffet or Jhunjhun. Better stick to good old method of asset allocation and periodical rebalancing. People who trade often loose in the end. Deepak should also mellow down his frequent trading advices.

  • Deepak Shenoy says:

    >anon: True – but I don’t think luck is a major factor. The harder you work, the luckier you get. There are traders who have returned far more than Buffet and Jhunjhunwala combined and are living very content lives. There are hedge fund managers that do over 200% a year consistently.

    To dismiss trading as a losing proposition is to ignore the facts; I think we need to understand trading as a psychology and work to discipline ourselves, rather than run off on tips or work only on asset allocation.

    I’d like to see how Asset Allocation would have worked in the last five years, ups and downs.

  • Anonymous says:

    >Dear Sir,

    Asset allocation has nothing to do with making a killing in the market. It is to do with discipline and making the best of the market within your means under all market conditions. It means “not getting rich” but “not getting poor”.

    Like you, I too know many veteran investors in India who have made tons of money without sweating or trading, only holding to real blue chips for very long time. They are having a nice retired life least concerned about market movements. They say “we are happy with our stock holdings as a percent of out total assets”.

  • Deepak Shenoy says:

    >Anon: I don’t think I said Asset Allocation is about making a killing. What I said is that Asset allocation is not the only disciplined thing available – even trading techniques can be extremely disciplined, and could actually provide greater risk control and returns.

    Holding on to blue chips is not asset allocation really – that’s buy and hold – and buy and hold has worked when you consider certain blue chips, but not others. For instance Burmah Trading was a blue chip in 1986.

    You may notice that stock holdings will form a considerably huge part of their holdings which they constantly book profits – and in all likelihood, if there is a bear market, they will not re-buy stocks, because at that time they will consider that further exposure is not good because of their age. That is really not asset allocation either.

    What I’d really like to see is how Asset allocation has worked in the last few years – perhaps it’ll be interesting to see the SD and drawdowns and returns.

    There’s a product by Benchmark Fudns (www.benchmarkfunds.com) called STRAP that allows you to buy into a PMS that does pure asset allocation. Could be a product of choice for those who want to use asset allocation but don’t have the time or discipline to do so…

  • Anonymous says:

    >Getting more interesting.

    I was watching the interview with Rakesh Jhun.. on CNBC. His asset allocation model ; 40 Lakhs in PPF and remaining in equities. That is an exception.

    But a nominal 40 to 60% in diversified equity MFs and remaining in debt should be decent mix (for good sleep in the night)for a volatile market like India. Frankly, after making some good money in the past I have sobered down (probably more wiser..) and reduced my Equity MF allocation to 30% presently.

    But I should really thank you for one great recommendation.. Arbitrage Funds. The next day after reading I invested about 50 Lakhs into 5 funds and they have given me 1% in the last one month.

    Best Regards