3 Lessons From Warren Buffett on Stock Market Volatility
Financial advisors often regard volatility as something to be feared.
Some experts even go as far as equating volatility to risk. For instance, “beta” – a measure of stock’s volatility- is treated as how risky a stock is relative to the market.
But legendary investor, Warren Buffet disagrees. He has been quoted numerous times on why he thinks volatility should not equate to risk and that investors should instead embrace volatile markets.
In a time when markets are becoming increasingly volatile due to the concerns of a trade war, no-deal Brexit and the Hong Kong protests, we could all use a quick reminder of what Buffett has said about volatility.
“Volatility is not a measure of risk… It’s (beta’s) a measure of volatility, but past volatility does not determine the risk of investing.”
As mentioned earlier, Buffett does not believe that volatility equates to risk. Just because a stock was volatile in the past, does not mean it makes a risky investment. He adds “Risk comes from the nature of certain kinds of businesses… if you understand the economics of the business in which you are engaged, and you know the people with whom you’re doing business, and you know the price you pay is sensible, you don’t run any real risk.”
As investors, we should understand that a stock’s price may move up and down over the short term. However, over the longer term, stocks will tend to gravitate towards their intrinsic value.
“The true investor welcomes volatility… a wildly fluctuating market means that irrationally low prices will periodically be attached to solid businesses.”
Long-term investors should view volatility as a positive because companies tend to get mispriced in this type of trading environment. This should enable investors to pounce opportunistically on stocks that may be trading irrationally below their true value.
“It should be an enormous advantage for investors in stocks to have those wildly fluctuating valuations placed on their holdings — and for some investors, it is.
After all, if a moody fellow with a farm bordering my property yelled out a price every day to me at which he would either buy my farm or sell me his — and those prices varied widely over short periods of time depending on his mental state — how in the world could I be other than benefited by his erratic behavior?
If his daily shout-out was ridiculously low, and I had some spare cash, I would buy his farm. If the number he yelled was absurdly high, I could either sell to him or just go on farming.”
In Berkshire Hathaway’s 2013 annual shareholder letter, Buffett describes a volatile stock market as an irrational seller of stocks. His example above perfectly illustrates how investors can take advantage of stock market mispricing due to the erratic volatility of the market.
When prices are low, we can simply add or hold on to our position and when prices are high we can either keep holding to get a better price in the future or to take advantage of the mispricing and sell.
The Foolish bottom line
By investing for the long term, we need not fear the downside effects of volatility on our portfolio. We should also use the opportunity that volatility affords to pick up shares on the cheap.
Hopefully, these three quotes inspire us to embrace volatility instead of fearing it.