The Rational Investor #001: Buffett on Bonds
Happy Saturday to you,
Welcome to the 1st edition of “The Rational Investor Newsletter.”
Today’s passage comes from Warren Buffett’s 2011 Shareholder Letter. It’s also included in its entirety in the wonderful book, The Essays of Warren Buffett which organizes the totality of Buffett’s shareholder letters by topic. The 8th edition of this book was released earlier this year and I highly recommend giving it a read if you haven’t already.
Now, onto today’s passage…
Here’s Warren Buffett on the “Risk” of Investing in Bonds (emphasis mine):
Investments that are denominated in a given currency include 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.
Over the past century these instruments have destroyed the purchasing power of investors in many countries, even as the holders continued to receive timely payments of interest and principal. The ugly result, moreover, will forever recur.
…
Even in the U.S., where the wish for a stable currency is strong, the dollar has fallen a staggering 86% in value since 1965, when I took over management of Berkshire. It takes no less than $7 today to buy what $1 did at that time. Consequently, a tax-free institution would have needed 4.3% interest annually from bond investments over that period to simply maintain its purchasing power. Its managers would have been kidding themselves if they thought of any portion of that interest as “income.”
For tax-paying investors, the picture has been far worse. During the same 47-year period, continuous rolling of U.S. Treasury bills produced 5.7% annually. That sounds satisfactory. But if an individual investor paid personal income taxes at a rate averaging 25%, this 5.7% return would have yielded nothing in the way of real income. This investor’s visible income tax would have stripped him of 1.4 points of the state yield, and the invisible inflation tax would have devoured the remaining 4.3 points. It’s noteworthy that the implicit inflation “tax” was more than triple the explicit income tax that our investor probably thought of as his main burden. “In God We Trust” may be imprinted on our currency, but the hand that activates our government’s printing press has been all too human.
I find it amazingly ironic that the greatest investor the world has ever known refers to bonds as “dangerous” and says “their risk is huge” while conventional wisdom (especially amongst retirees) still maintains that bonds are “safe.” As long-term investors, we should take note.
I created the image below as a visual representation of this quote:
Thanks for reading. I’ll be back again next week with more timeless wisdom from great investors.
Enjoy the weekend!
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