Teaching points from Warren Buffet’s annual letter 2011

Investing is often described as the process of laying out money now in the expectation of receiving more money in the future. It can be more simply described as investing is forgoing consumption now in order to have the ability to consume more at a later date.

The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the chance – the reasoned chance – of that investment causing its owner a loss of purchasing-power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period. And as we will see, a non-fluctuating asset can be laden with risk.

Investment possibilities are both many and varied. There are three major categories, however, and it’s important to understand the characteristics of each.

  1. Currency based instruments: cash, bonds. These will severely erode purchasing power in the long run
  2. Non productive assets: gold. These might keep up with inflation but are worse than productive assets
  3. Productive assets: businesses, farms or real estate. These are the best instruments over the long run. They can be divided into two subcategories:
  • Assets that have the ability in inflationary times to deliver output that will keep its purchasing-power value while requiring a minimum of new capital investment. These are the best.
  • Assets that need heavy capital requirements. To earn more, their owners must invest more. Even so, these investments will remain superior to unproductive or currency-based assets.
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