Are Currency-Based Assets And Investments Safe?
Most institutional investors define risk in terms of beta, the amount one’s portfolio fluctuates compared to the fluctuation of a comparable index. All measurements of beta now include the huge market meltdown of 2008. Consequently, investors have organized their asset allocation around surviving the worst possible 12-month period we have seen since WWII. They have become highly over-committed to bonds, gorging on them for three consecutive years.
Warren Buffett discussed his view of risk in this year’s letter to his Berkshire Hathaway shareholders, and it’s very different from a simple beta measurement. Buffett begins by breaking down the three categories of investment: Currency-based investments (money market funds, CDs, bonds, etc.), unproductive assets (gold, art, collectibles, etc.), and productive assets (common stocks, farmland, and real estate). In any discussion of risk, Buffett asks for an increase in purchasing power above the inflation rate. In other words, he believes loss of purchasing power is the biggest long-term risk we face. Following are some excerpts from his 2012 letter:
“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. 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.
… the dollar has fallen a staggering 86% in value since 1965… it takes no less than $7 today to buy what $1 did at that time… 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.”
The “Greater Fool” Theory–Unproductive Assets
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 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. As bandwagon investors join the party, they create their own truth – for a while.
Our country’s businesses will continue to efficiently deliver goods and services wanted by our citizens. Metaphorically, these commercial “cows” will live for centuries and give ever greater quantities of “milk” to boot. Their value will be determined not by the medium of exchange but rather by their capacity to deliver milk. Proceeds from the sale of milk will compound for the owners of the cows, just as they did during the 20th century when the Dow increased from 66 to 11,497 (and paid loads of dividends as well). I believe that over any extended period of time this category of investing will prove to be the runaway winner among the three we’ve examined. More important, it will be by far the safest.”
“Oracle and Omaha” and Time Horizon
When it comes to investing, The “Oracle of Omaha” seems to be a perpetual fount of wisdom. But remember one important point that’s implicit in Buffett’s view: In order to receive the purchasing power benefits stock ownership can offer, a proper time horizon is critical. This has always been problematic for retail investors, especially during volatile markets. A two-to-three month, or even a one-year holding period won’t cut it. It’s anyone’s guess what stocks might do over such short time-frames. Five-to-ten years is the minimum period Buffett would expect to hold something.
Learn more about how you can review various currency-based assets to help diversify your portfolio with Redhawk Wealth Advisors and www.redhawkgoldandsilver.com.