Absolutely. To invest successfully you need to manage risk, not avoid it. Warren Buffett has understood every aspect of this and made a lot of money executing the idea.
By focusing on good companies with steady cash flows and high return on equity, he has been able to increase his wealth even at the worst of times.
This is in sharp contrast to resource investing where a mediocre year may be followed by an excellent year – all depending on commodity prices.
The question then becomes “How did Warren Buffett manage the risk?”
Some of his holdings may have seen exceptionally big in respect to his whole portfolio at times, and you would be forgiven to believe that he was putting all his money at risk. But then you realize that he wasn’t gambling at all.
He could at all times liquidate his holdings in American Express, Coca-Cola or Wells Fargo and at least get what he paid for them back. In this sense it has been clear that Buffet has been taking very little financial risk.
The environment in which he made his money was every bit as uncertain as the one that we have today. Yet, he was able to steer clear and make a lot of money.
Today there is rapid credit growth, quantitative easing by the central banks and a potential bubble in China to worry about. When Warren Buffett started investing in the sixties and seventies, the worries were different but no less severe.
You often hear things like “Financial markets don’t like uncertainty”, but that is only half-right. Financial markets may not like uncertainty, but good investors thrive.
That all sounds very good, but what is the best thing that I can do with my money?
When you read this you may think that it is only to invest in a few good stocks and you’re ready to go off and settle on the beach, but it also takes a lot of psychological strength to be able to go with just a few stocks like Warren Buffet has done.
The strategy that we recommend is to diversify your portfolio in order to spread the risk.
If you don’t consider yourself to be a Master of investing who turn all that he touches into gold, to diversify your holdings would seem to be the most prudent strategy.
Today we have been talking about the success of Warren Buffett and how he has managed to make a lot of money even when times were rough.
He did so not by investing in the fastest growing companies, but in companies that had the safest cash flows.
We have also talked about diversifying your portfolio if you haven’t identified stocks with good cash flows at the exact good time point to invest.
The reason why we recommend you to do this is that it spreads the risk that you run from owning just a few companies.
Published on the 1’st of September 2016