“But if it makes a difference to you whether your stocks are down 15% or not, you need to get a somewhat different investment philosophy because the world is not going to adapt to you. You’re going to have to adapt to the world.” — Warren Buffett, 60th Annual Meeting, May 2025
Investors, their advisors, and even regulators agree that an investor should allocate capital according to his risk profile. This is composed of two different things.
First is the risk-taking capacity based on their financial circumstances, investment horizon etc.
Second is the psychological response handling capacity when the actual risk takes place. The first one is what we can call the hard aspect of risk profile and the second is the soft aspect.
If someone’s financial situation is too precarious in terms of uncertain income, high debt, or too many dependents compared to the income, then it is a hard issue, and one cannot do much about it until these circumstances change.
However, if the above doesn’t apply and they have a stable income, no or limited debt, and family expenses which are reasonable compared to their income, and no major liabilities in the near-to-midterm, then they do not have a hard constraint on their risk-taking capability.
Their financial situation allows them to take risks. However, many people in such situations would turn out to have a conservative risk profile.
These are the people who would invest in a risky asset class like equities because it is rewarding, but then start feeling uncomfortable when markets drop by 15% to 20%. This is what Buffett is talking about.
If one cannot handle such a drop then one has two choices. Either, they choose not to invest in a risky—rather volatile—asset class like equities.
Or, they choose to train themselves to have a higher psychological risk-handling capacity. The first choice looks easy and most advisors would just advise the investor that since they have a “conservative” risk profile they should not take too much exposure to equities.
The second choice is for the investor to make; hardly any advisor would suggest that. Given the advances in healthcare and the average understanding and focus on fitness, most investors today would be looking at a long life quite close to 100.
If they retire at 60 or 65, they have roughly 30-35 years of income generating work life and 35-40 years of retirement spending to support from the corpus created during the working life.
The challenge with a long retirement period is that inflation starts eating into the corpus. If one is not invested in inflation-beating assets like equities, one has the risk of running out of capital when they are old. At that time one will not be able to talk to their advisors who advised a “conservative” asset allocation.
It will be too late to realize that the so-called “conservative” allocation was actually the riskiest allocation when you run out of money at 85 or 90 when you cannot physically go back to earning money.
Thus, it becomes important for the investor to do this analysis himself or herself. They have to see if their targeted corpus can help them spend throughout a long life; especially, a life with rising health costs.
If not, they need to learn to save a higher amount and also allocate it to a higher-risk, higher-reward asset class like equities. However, they also need to recognize that currently they do not have the psychological risk-taking ability. So they need to chart out a training program for themselves.
The training program can have two components. One education, and the other, experience.
One needs to become educate oneself about equities. Aspects of equities like how equities generate returns? What is the source of those returns? How does an unlisted company or business generate returns? What happens when the same business is listed? Do the sources of returns remain the same or something mysteriously changes just because it is listed?
What do the fluctuations or volatility in listed equities mean to the long-term investor? Should one sell or buy when equities go down? How to value equities? How to compare intrinsic value to the market price? Should one follow Mr. Market or take advantage of him? Such issues are what a scientific investor would try to become knowledgeable about over a period of time.
Second, one needs to start gaining experience. As the old saying goes, no amount of reading books and watching videos about swimming can help one learn swimming. One has to jump in the pool to learn how to swim.
Similarly, a conservative investor can initiate with an amount allocated to equities which is neglible compared to their net worth. This is the amount they decide they are willing to lose, as “tuition fees”, to learn about equities. They allocate this amount and watch this tiny portfolio go up and down and bounce back or recover etc.
They choose the stocks in it based on the knowledge they taught themselves in the earlier education step. Slowly, they will lose some money on some stocks and gain on some others. They will watch themselves panic or learn becoming more resilient, stoic and scientific.
Over a period of time, could be years, they would become a scientific investor who invests with originality, i.e., a portfolio different from the market, has character to invest larger and larger sums of money to this original portfolio, and has the patience to let the allocation deliver on its promises through ups and downs.
For the second part the investor just has to learn from their own experience. But for the first part the investor can get a strong foundation if he or she follows the scientific investing framework. There are only a few commandments to follow.
Do not invest in capital destroyers, meaning highly leveraged and consistently loss making companies.
Do not invest in capital eroders, meaning, companies with low return on capital which shows they do not have a competitive edge.
Do not invest in capital imploders, meaning, companies with extremely high valuation ratios, such as, PE of 50+ or PBV of 5-10+ etc.
Do not invest in companies growing much slower than nominal GDP.
Do not invest more than 5% in a single company.
Do not invest more than 40% in a single industry.
Do not invest and forget. Keep reviewing the quarterly and annual financials of a company.
Make changes when required if these conditions are not met.
This is one way to implement Buffett’s advice to change one’s investment philosophy. Happy investing!
(The author is CEO & Chief Investment Strategist at OmniScience Capital)
(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)
Investors, their advisors, and even regulators agree that an investor should allocate capital according to his risk profile. This is composed of two different things.
First is the risk-taking capacity based on their financial circumstances, investment horizon etc.
Second is the psychological response handling capacity when the actual risk takes place. The first one is what we can call the hard aspect of risk profile and the second is the soft aspect.
If someone’s financial situation is too precarious in terms of uncertain income, high debt, or too many dependents compared to the income, then it is a hard issue, and one cannot do much about it until these circumstances change.
However, if the above doesn’t apply and they have a stable income, no or limited debt, and family expenses which are reasonable compared to their income, and no major liabilities in the near-to-midterm, then they do not have a hard constraint on their risk-taking capability.
Their financial situation allows them to take risks. However, many people in such situations would turn out to have a conservative risk profile.
These are the people who would invest in a risky asset class like equities because it is rewarding, but then start feeling uncomfortable when markets drop by 15% to 20%. This is what Buffett is talking about.
If one cannot handle such a drop then one has two choices. Either, they choose not to invest in a risky—rather volatile—asset class like equities.
Or, they choose to train themselves to have a higher psychological risk-handling capacity. The first choice looks easy and most advisors would just advise the investor that since they have a “conservative” risk profile they should not take too much exposure to equities.
The second choice is for the investor to make; hardly any advisor would suggest that. Given the advances in healthcare and the average understanding and focus on fitness, most investors today would be looking at a long life quite close to 100.
If they retire at 60 or 65, they have roughly 30-35 years of income generating work life and 35-40 years of retirement spending to support from the corpus created during the working life.
The challenge with a long retirement period is that inflation starts eating into the corpus. If one is not invested in inflation-beating assets like equities, one has the risk of running out of capital when they are old. At that time one will not be able to talk to their advisors who advised a “conservative” asset allocation.
It will be too late to realize that the so-called “conservative” allocation was actually the riskiest allocation when you run out of money at 85 or 90 when you cannot physically go back to earning money.
Thus, it becomes important for the investor to do this analysis himself or herself. They have to see if their targeted corpus can help them spend throughout a long life; especially, a life with rising health costs.
If not, they need to learn to save a higher amount and also allocate it to a higher-risk, higher-reward asset class like equities. However, they also need to recognize that currently they do not have the psychological risk-taking ability. So they need to chart out a training program for themselves.
The training program can have two components. One education, and the other, experience.
One needs to become educate oneself about equities. Aspects of equities like how equities generate returns? What is the source of those returns? How does an unlisted company or business generate returns? What happens when the same business is listed? Do the sources of returns remain the same or something mysteriously changes just because it is listed?
What do the fluctuations or volatility in listed equities mean to the long-term investor? Should one sell or buy when equities go down? How to value equities? How to compare intrinsic value to the market price? Should one follow Mr. Market or take advantage of him? Such issues are what a scientific investor would try to become knowledgeable about over a period of time.
Second, one needs to start gaining experience. As the old saying goes, no amount of reading books and watching videos about swimming can help one learn swimming. One has to jump in the pool to learn how to swim.
Similarly, a conservative investor can initiate with an amount allocated to equities which is neglible compared to their net worth. This is the amount they decide they are willing to lose, as “tuition fees”, to learn about equities. They allocate this amount and watch this tiny portfolio go up and down and bounce back or recover etc.
They choose the stocks in it based on the knowledge they taught themselves in the earlier education step. Slowly, they will lose some money on some stocks and gain on some others. They will watch themselves panic or learn becoming more resilient, stoic and scientific.
Over a period of time, could be years, they would become a scientific investor who invests with originality, i.e., a portfolio different from the market, has character to invest larger and larger sums of money to this original portfolio, and has the patience to let the allocation deliver on its promises through ups and downs.
For the second part the investor just has to learn from their own experience. But for the first part the investor can get a strong foundation if he or she follows the scientific investing framework. There are only a few commandments to follow.
Do not invest in capital destroyers, meaning highly leveraged and consistently loss making companies.
Do not invest in capital eroders, meaning, companies with low return on capital which shows they do not have a competitive edge.
Do not invest in capital imploders, meaning, companies with extremely high valuation ratios, such as, PE of 50+ or PBV of 5-10+ etc.
Do not invest in companies growing much slower than nominal GDP.
Do not invest more than 5% in a single company.
Do not invest more than 40% in a single industry.
Do not invest and forget. Keep reviewing the quarterly and annual financials of a company.
Make changes when required if these conditions are not met.
This is one way to implement Buffett’s advice to change one’s investment philosophy. Happy investing!
(The author is CEO & Chief Investment Strategist at OmniScience Capital)
(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
