The professional investor who is benchmark agnostic, who doesn’t seek to eke out every penny of return at the expense of risk, who focuses on downside protection, and who is not handcuffed by a certain business model – be it active, passive or otherwise – has better odds of controlling for volatility. Contrary to popular belief, the famed investor Warren Buffet has managed to compound wealth at many times the market index not by shooting for the stars, but by investing in lower-volatility assets. The annual standard deviation of the Berkshire portfolio since inception has averaged 14.6% versus the S&P500 at 17.5%, a seemingly small difference. However, Buffet’s focus on lower risk has allowed the strategy to participate in significantly less market downside, avoiding the toxic effect of volatility drag on longer-term wealth creation (see figure below). In other words, it’s not nearly as important to beat the market when the market is up as it is to beat it when it’s down. In Buffet’s own words
“it’s not necessary to do extraordinary things to get extraordinary results.”
This is an excerpt from our article “Volatility Drag: Why a rigid investment model may be hazardous to your wealth” published September, 2012.