Safety or security – you can’t have both

Published in The Sunday Times on 23rd February 2025.

Warren Buffett once described investing as “the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power in the future”. This is the best definition of investing I have ever encountered. The measure of risk implicit in Buffett’s definition is inflation risk. There’s no mention of that obscure concept the financial services industry is in thrall to - volatility. As the European Central Bank (ECB) continues to cut interest rates this is becoming increasingly important. The price of managing volatility is going up. This shouldn’t concern the average investor, but it seems to.

Safety and security are seemingly synonymous terms. We regularly hear the refrain, ‘safe and secure’. But as it relates to investing, they are very separate terms.

Safety in an investment sense is to be found in liquid assets with very little prospect of capital loss and low levels of volatility. Cash and equivalents (money market funds and short-term bonds) achieve this goal and manage volatility risk. 

Security is to be found in assets that have historically provided protection from inflation e.g. equities and real assets. Such that your portfolio maintains or grows its purchasing power as Buffett described. These are assets we traditionally think of as ‘high’ risk. I’ve always struggled with this determination of assets as high and low risk by reference only to their volatility.  

The problem for many investors is that they tend to conflate the two; assuming safety can be achieved whilst also delivering security. But it’s an either/or. There are two main risks in the investment world: (a) the risk of losing money and (b) the risk of missing opportunity. You can completely avoid one or the other, or you can compromise between the two, but you can't eliminate both. In my experience, investors want safety (avoidance of short-term losses) but need security (to protect the real value of their portfolios). So how do we reach a compromise between the two?

This is of renewed importance as interest rates are now on a downward cycle, which means the price for safety (or certainty) is going up. At the same time, the price for security looks like it’s never been higher, with stock markets trading near all-time highs. As Buffett concedes, nobody said this was ever going to be easy.

2024 marked the 60th anniversary of the inception of Buffett’s investment vehicle, Berkshire Hathaway. It’s a remarkable 60-year track record. From 1965 – 2024, Berkshire shares have compounded at an annualised rate of 20%, almost double the 10.4% return for the S&P 500 (both in USD terms). A $1 investment in the S&P 500 would have returned $380 over this period. The magic of compounding has turned Buffett’s $1 into a hardly credible $55,000.   

The Berkshire journey was not without disappointment. There were 20 years when Buffett’s return was below that of the market. There’s a lesson in that. One of the world’s best long-term investors can deliver disappointment one-third of the time, and still come out considerably ahead.

Buffett is the poster boy for active, long-term, value investing. There’s an awful lot to be learned from him, but the lessons are not helpful at times like this, with markets trading at all-time highs. 

Stock markets have resembled perpetual money-making machines over the last decade - the S&P 500 has compounded at over 13% per annum (in USD terms). With markets at all-time highs and valuations stretched, losses feel almost inevitable. 

The lessons from Buffett are to be patient, think long-term, and ignore volatility. This is the equivalent of telling someone the key to losing weight is eating less and exercising more. We know. 

I’m confident in the assertion that the best way to achieve long-term security is through investing in real assets and businesses. I’m confident this will involve inevitable losses. However, I’m not confident in my ability to action any decision because it’s not easy losing money (even if it is only temporary), and the temptation to buy at lower levels is overwhelming. 

The fact that stock markets are expensive today does not mean they will decline tomorrow. Stock markets are not bound by the laws of physics, they are governed by the uncertainties of human psychology. Waiting for a better entry point is a fool’s errand. 

There is an imperfect antidote for this; stagger your investment into the market. Phasing has rarely proven to be a worthwhile strategy as the long-term evidence favours investing all at once. But this is letting the perfect be the enemy of the good. 

Phasing might be a slightly inferior approach, but it’s nowhere near as inferior as scared money sitting on the sidelines waiting for prices to drop.

We all want safety. That’s easy. Security is anything but. If it was easy, it wouldn’t be this lucrative.    
  

Source: Data is sourced from Bloomberg as at market close 31st December, returns are based on total indices in local currency terms, unless otherwise stated.

Gary Connolly is Investment Director at Davy. He can be contacted at gary.connolly@davy.ie or on X at @gconno1.