Managing Your Portfolio 165Buffett’s View of Risk
In modern portfolio theory, the volatility of the share price def ines risk.
But throughout his career, Buffett has always perceived a drop in share
prices as an opportunity to make 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’ def inition of
risk is far off the mark, so much so that it produces absurdities.”^9
Buffett has a different definition of risk: the possibility of harm.
And that is a factor of the intrinsic value of the business, not the price
behavior of the stock. Financial harm comes from misjudging the fu-
ture prof its of the business, plus the uncontrollable, unpredictable effect
of taxes and inf lation.
Furthermore, Buffett sees risk as 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.
The odds of predicting whether share prices will be up or down in a
short period are the same as the odds of predicting the toss of a coin;
you will lose half of the time. However, says Buffett, if you extend your
time horizon out to several years (always assuming that you have made
a sensible purchase), then the odds shift meaningfully in your favor.
Buffett’s View of Diversification
Buffett’s view on risk drives his diversif ication strategy, and here, too,
his thinking is the polar opposite of modern portfolio theory. Accord-
ing to that theory, the primary benef it of a broadly diversif ied portfo-
lio is to mitigate the price volatility of the individual stocks. But if you
are unconcerned with price volatility, as Buffett is, then you will also
see portfolio diversif ication in a different light.
He knows that many so-called pundits would say the Berkshire
strategy is riskier, but he is not swayed. “We believe that a policy of
portfolio concentration may well decreaserisk if it raises, as it should,
both the intensity with which an investor thinks about a business and
the comfort level he must feel with its economic characteristics before
buying into it.”^10 By purposely focusing on just a few select companies,
you are better able to study them closely and understand their intrinsic