Warren Buffett's Letter Analyzed for Conservative Savers and Investors

Warren Buffett's Letter Analyzed for Conservative Savers and Investors

Warren Buffett published an interesting article in Fortune today that illuminates his thinking on the attractiveness of different investment classes. While I don't hang on Warren Buffett's every word, I thought some of his analysis pertinent for BestCashCow savers and investors.

Warren Buffett published an interesting article in Fortune today that illuminates his thinking on the attractiveness of different investment classes. While I don't hang on Warren Buffett's every word, I thought some of his analysis pertinent for BestCashCow savers and investors.

A large part of the letter is reserved for discussing what he calls "currency based investments," including money market funds, bonds, mortgages, bank deposits, and other instruments. Savings accounts, money market accounts, and certificates of deposit would fit into this category. These investments are normally thought of as having little to no risk although Buffett said that:

"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."

He says this because inflation can rapidly erode the purchashing power of these investments over time, especially when inflation is higher than interest rates. Inflation ran at 3% last year according to the government's CPI numbers but the average savings account rate is just 0.20% APY while the average 3 year CD is just 1.04% APY. Over time, assuming inflation stays the same or increases, money deposited in this environment will lose value, even after interest is added.

Interestingly, while Buffett tells investors that he doesn't currently favor safe assets, he also admits that Berkshire Hathaway "holds significant amounts of them [currency based investments], primarily of the short-term variety. At Berkshire the need for ample liquidity occupies center stage and will never be slighted, however inadequate rates may be." Buffett admits what any good investor knows: that a portion of a portfolio needs to be in cash, not matter how bad the return.

The reason we've always encouraged our readers to shop for rates, is so that they can earn the highest possible return on that safe investment portion of their portfolio. The average 3 year CD may pay 1.04% APY but the best 3-year CD rate is 2.30% APY. That 1.26% APY difference is significant and will help prevent inflation from eroding the value of your safe money.

What about municipal bonds, which are also included in currency based investments? Yields on munis are exceptionally low today. To earn any type of decent return, an investor needs to go out 30 years. If interest rates and inflation rise, that will both reduce the value of the bond (as interest rates rise, the value of a bond falls) and also erode the value of bond payments. Can rates go lower? Yes, especially with the Fed hinting at more easing. But longer term, over the next 10-20 years there is a much greater chance that rates will rise.

Gold is Just a Metal

Buffett does not like gold and he makes an interesting comparison to prove his point. The value of all the world's gold is about $9.6 trillion. Physically, it could all fit into a normal sized baseball field. For that amount, an investor could buy all the U.S. cropland (400 million acres with $200 billion in annual output), 16 Exxon Mobils (the world's most profitable company), and still have $1 trillion left over. Which one would you rather have? Which do you think will be worth more in 10 years?

He Likes Productive Assets

Buffett likes productive assets - businesses, farms and real estate. These assets retain value even in inflationary times because producers can raise prices. Even if the currency appreciates, people still need to buy food, clothing, fuel, medicine, books, tools, etc.

For the conservative BestCashCow investor, dividend stocks represent a good way to both generate income and hedge against inflation. Stocks like AT&T, Verizon, and Merck pay out over 4% and provide an opportunity for appreciation (note: these stocks can also go down which is why they should not be in the "safe part" of an investor's portfolio).

Image: Image courtesy of Serge Bertasius Photography at FreeDigitalPhotos.net

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