Risk tolerance: lessons from Warren Buffett and why I avoid Bitcoin

Investing and risk go hand in hand. That’s no surprise. All investments involve an element of risk. With some, this risk is more inherent than elsewhere. Look at Bitcoin, which I perceive as a wildly volatile and dangerous investment, compared to a Cash ISA. But although you probably won’t make a paper loss with the Cash ISA, you’re unlikely to keep up with the rate of real-life inflation. Therefore, both of these investments are layered with risk.

Time in the market

Looking at Bitcoin, my concerns are that the price is too unpredictable. Admittedly, when viewed on a short-term basis, the same conclusion can be drawn about shares.

However, I know that if a company’s revenue has grown over the years, if it is managed by good people and has a competitive edge over its rivals, the likelihood is that its share price will grow over time.

Investing successfully takes years. Risk is usually lessened by the length of period that an investor is in the market. Reinvested dividends and compound interest can add to growth.

Warren Buffett understands this, and encapsulated the logic by saying that “someone is sitting in the shade today because someone planted a tree a long time ago”.

Only invest in what you understand

I’ll admit it: I don’t fully understand Bitcoin. I’ve read a lot about cryptocurrencies, I’ve watched documentaries about them too. And I know people are making huge gambles that this could be the currency of the future.

However, to draw that conclusion seems like a huge leap of faith to me.

I can only justify investing in something that I fully understand. That’s why my preferred stocks tend to be in businesses that are well-established and operate in traditional industries. If such a firm has a new way to generate revenue, it’s likely that I’d seek out something in it to invest in, but only if I understand it.

Buffett’s tip here is to “never invest in a business you cannot understand.”

Avoiding disaster

Don’t lose money. That’s the advice ingrained in most investors’ minds. Some of Warren Buffett’s biggest successes have been by not falling victim to the failings of the market.

Take the dotcom bubble. Valuations of tech companies skyrocketed, and then plummeted. People lost millions from their portfolios.

But not Warren Buffett, who had managed to avoid the bubble because he was reluctant to invest in something he didn’t understand.

Buffett only tends to invest in businesses he’s confident will make him money. He wouldn’t part with cash for outside odds. Protecting capital needs to be an investor’s primary goal.

Investing should not feel like you’re at the casino. Instead, your philosophy should be more calculated, like focusing on great companies with growth prospects. It shouldn’t feel risky.

As Buffett has said in the past, there are two rules of investing: “Rule No. 1: never lose money. Rule No. 2: never forget rule No.1″.