True Investment Lesson from Warren Buffet

As the world moving towards inflation age, every government want to print more money to solve certain problems. The fast increasing new money made normal people lose their purchase power, and every one is eager to find out a way to maintain their current wealth.

So many investment managers are showing people of different investing ways, such as gold, oil, P2P, stock, real estate, etc, and promising huge returns in a short time. The result is always turned out that these investment advisors made a lot of fortune for their agent fee, and the investors (or speculator is more appropriate) lose a lot of money. When the bubble starts, they forgot past again. History is always similar.

Here comes the true investment lesson from Warren Buffet to Berkshire Hathaway shareholder letter in 2011. His definition of three investing categories gives me much insights to investment, and the real investing is as the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power – after taxes have been paid on nominal gains – in the future. The riskiness of an investment is not measured by beta(a Wall Street term encompassing volatility and often used in measuring risk), but rather by the probability- the reasoned probability -of that investment causing its owner a loss of purchasing power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period.

The basic Choices for Investors and the One Warren Buffet Strongly prefer— The following are some important excerpts from my perspectives from Warren Buffet to Berkshire Hathaway shareholder letter in 2011, if you want to read in details, I strongly suggest you need to read the shareholder letter at least 10 times.

Investment possibilities are both many and varied. There are three major categories, however, and it’s important to understand the characteristics of each.

1. 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 maybe 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. This ugly result, moreover, will forever recur. Governments determine the ultimate value of money, and systemic forces will sometimes cause them to gravitate to policies that produce inflation. From time to time  such policies spin out of control.

Even in the US, 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 $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”.

Under today’s conditions, therefore, I do not like currency-based investments. Even so, Berkshire holds significant amounts of them, 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. Accommodating this need, we primarily hold US Treasury bills, the only investment that can be counted on for liquidity under the most chaotic of economic conditions. Our working level for liquidity is $20 billion; $10 billion is our absolute minimum.

2. The second major category of investments involves assets that will never produce anything, but that are purchased in the buyer’s hope that someone else- who also knows that the assets will be forever unproductives- will pay more for them in the future. Tulips, of all things, briefly became a favorite of such buyers in the 17th century.

This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce- it will remain lifeless forever- but rather by the belief that others will desire it even more avidly in the future.

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). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.

Over the past 15 years, both Internet stocks and houses have demonstrated the extraordinary excesses that can be created by combining an initially sensible thesis with well publicized rising prices. In these bubbles, an army of originally skeptical investors succumbed to the “proof” delivered by the market, and pool of buyers- for a time- expanded sufficiently to keep the bandwagon rolling. But bubbles blown large enough inevitably pop. And then the old proverb is confirmed once again:”what the wise man does in the beginning, the fool does in the end”.

3. Our first two categories enjoy maximum popularity at peaks of fear: Terror over economics collapse drives individuals to currency- based assets, most particularly US obligations, and fear of currency collapse fosters movement to sterile assets such as gold. We heard “cash is king” in late 2008, just when cash should have been deployed rather than held. Similarly, we heard “Cash is trash” in the early 1980s just when fixed-dollar investments were at their most attractive level in memory. On those occasions, investors who required a supportive crowd paid dearly for that comfort.

My own preference- and you knew this was coming- is our third category: investment in productive assets, whether business, 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. Farms, real estate, and many businesses such as Coca-Cola, 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.

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