2. "Fake Risk" that is triggered by mere price changes can be completely eliminated through a longer investing time horizon. With a well informed investing decision and prepare to stay for a longer time zone, we can keep the return high without such "Fake Risk". This definition of risk is being used by academics and professionals. We denote it Risk(a).
("Fake Risk", at FPM, is what Buffett referring to as "academic's definition of risk--the volatility of the share price". I know by labelling such academic and professional definition of risk(a) as "Fake Risk" I can be rediculed by many. But if you able to think logically you will understand volatility does not create risk nor does it create possibility of loss, if you are able to hold a good stock for long term.)
This is one of the most important sections of the book--The Essential Buffett, by Robert G. Hagstrom.
Buffet's View of Risk
In modern portfolio theory, risk is defined by the volatility of the share price. But, through out his career, Buffett has always perceived a drop in share prices as opportunity to make additional money. In his mind, then, a dip in price actually reduces risk. He points out, "For owners of a business--and that's the way we think of shareholders--the academics' definition of risk is far off the mark, so much so that it produces absurdities." (Berkshire Hathaway Annual Report, 1993, p.13)
Buffet has a different definition of risk: the possibility of harm or injury (in other words, permanent loss in the value of investment). And that is a factor of the "intrinsic value risk" of the business, not the price behavior of the stock. ...harm or injury comes from misjudging the future profits of the business, plus the uncontrollable, unpredictable effect of taxes and inflation.
Furthermore, risk, for Buffett, is inextricably linked to an investor's time horizon. If you buy a stock today, he explains, with the intention of selling it tomorrow, then you have entered into a risky transaction. ...But in Buffett's way of thinking, buying Coca-Cola this morning and holding it for ten years puts the risk at zero.
These two points are the basis of FPM's investing philosophy. When we assessing the risks of investment, remember to differentiate true risk, risk(t), from fake risk, risk(a).
