Buffett: Stocks Beat Bonds

Fortune recently published an article by Warren Buffett where the Oracle of Omaha divides the investment world into these three asset classes:

  • Investments denominated in a given currency, including money-market funds, bonds, mortgages, bank deposits, and other instruments. “Most of these currency-based investments are thought of as safe. In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge,” writes Buffett.
  • Assets that will never produce anything, but that the buyer hopes someone will pay then more for in the future. “Tulips, of all things, briefly became a favorite of such buyers in the 17th century,” notes Buffett. “Today, the major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful).”
  • Investments in productive assets like businesses, farms, or real estate. “Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment,” Buffett writes. “Farms, real estate, and many businesses such as Coca-Cola (KO), IBM (IBM), and our own See’s Candy meet that double-barreled test. Certain other companies — think of our regulated utilities, for example — fail it because inflation places heavy capital requirements on them. To earn more, their owners must invest more. Even so, these investments will remain superior to nonproductive or currency-based assets.”

Buffett says that stocks will be the “runaway winner” over the long-term, however, “currency based” and “sterile assets” will always be the most popular when fear preys upon the market. In fact, in the wake of ongoing volatility, investors have pulled money from U.S. stock mutual funds each of the last five years, including $100 billion in 2011. And at the same time, they poured money into bond funds each of the last six years, including $110 billion last year.

Notably, those saving for retirement or supporting themselves in retirement have a different investment horizon than Buffett’s “forever.” And that’s where we come in — working with clients to identify their goals and risk tolerance, build an appropriately diversified asset allocation plan, and manage the portfolio based on reason, not emotion.

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