Buffett on Volatility and Risk

Continuing from last week’s discussion about the difference between volatility and risk, here are comments made by Warren Buffett on this topic at the 2007 Berkshire annual general meeting:

…  Volatility is not a measure of risk.

… people who have written and taught about [risk] do not know how to measure risk.

And the nice thing about beta, which is a measure of volatility, is that it’s nice and mathematical and wrong in terms of measuring risk. It’s a measure of volatility, but past volatility does not determine the risk of investing.

… Here in 1980, or in the early 1980s, farms that sold for $2,000 an acre went to $600 an acre…

And the beta of farms shot way up. And, according to standard economic theory or market theory, I was buying a much more risky asset at $600 an acre than the same farm was at 2,000 an acre.

… people … would regard that as nonsense …

But in stocks, because the prices jiggle around … and because it lets … people who teach finance use the mathematics they’ve learned, they have … in effect, translated volatility into all kinds of … measures of risk.

And it’s nonsense.

Risk comes from the nature of certain kinds of businesses. It can be risky to be in some businesses just by the simple economics of the type of business you’re in, and it comes from not knowing what you’re doing…

It’s just the whole development of volatility as a measure of risk, it has really occurred in my lifetime. And it’s been very useful for people who wanted a career in teaching, but it is not — we’ve never found a way for it to be useful to us.