Buffett: Bonds the Most Dangerous of Assets

[MichaelB]

I have great respect for Warren Buffet. Nonetheless, he is much more concerned with business risk, while my concern is portfolio sustainability, so I find his view interesting but not useful. Just because equities may prove to hold value better than Treasuries does not make them good investments right now. Just because a turd doesn't smell so bad does not make it tastier or any more fit for consumption.

 

[Texas Proud]

If I had net worth of 50 billion dollars I might feel the same way he does. If his portfolio drops 50% in a week or two he still has 25B. I'm eating Alpo.

What You would be eating Alpo if HIS portfolio dropped 50%


Just having a bit of fun....

 

[Texas Proud]

XOM has been very good to my family.

+1 but only to my mom...

 

[audreyh1]

There are several things to keep in mind:

1. Buffet is only looking at the long term. From his perspective, that is the only view that matters. For retirees with less than a 30 year time frame and living off their investments, long-term purchasing power is probably half the view. This is a good warning for not-that-old folks holding very high allocations in bonds IMO.

2. I don't sweat the currency stuff too much, as my expenses are also denominated in $$. I do however have some international exposure via equities and a small percentage of international bonds.

3. Gold? I don't hold any. Never could bring myself to buy any. Maybe I just remember gold's horrible performance during my younger years. And if I don't physically possess it, I don't see the point during political crisis/war periods anyway. Where would I escape to? Mexico?

I doubt I would ever be that comfortable holding much less than 50% in equities for the longevity issues, but I prefer to hedge my bets for the shorter term issues .

I know there are issues with bonds right now. I fully expect to see a 5% or maybe even a 10% haircut on my bond holdings in the next 5 or 10 years as interest rates "normalize". I'm OK with that, as I expect to be able to replenish from my equity funds over time to rebuild the bond portion. And who knows - we might still end up with a super long period with low interest rates and no "normalization". We just don't know.

Best just to stay diversified across several asset classes and not too highly concentrated in any one. IMO this is the best way to handle both the short term and long term issues.

Audrey

 

[Hamlet]

I think that there is a difference between keeping some gold as a fail safe emergency safety net and keeping a large chunk of your portfolio in it as an investment.

In the situations you are describing, having some physical gold is very useful, but having 10% of your investments in GLD doesn't give that same utility.

I think it is important that people understand that gold is a store of value, but it isn't an investment. It may gain or lose market value through speculation, but it doesn't add to its intrinsic value over time as a good company does.

How did rich landowner invested in the Russian farm land do in 1919 or China farm land in 1949 do? By 1946 there was so much famine in Russia one million people died. How does that compare to the people who owned gold and was able to take their wealth with them out of the country? Between 1949 and 1953 it is estimated one million "evil" landowners in China were executed. Most of the gold of China ended in Taiwan, where people with gold fled to in 1949. per Wiki"When the KMT government fled to Taiwan it brought millions of taels of gold and the foreign currency reserve of mainland China to the island, which, according to the KMT stabilized prices and reduced hyperinflation.[73] Perhaps more importantly, as part of its retreat to Taiwan, the KMT brought the intellectual and business elites from mainland China.

I believe in the value of stocks, but making one self ignorant of the value and utility of gold in very bad times and placing faith in pieces of paper can be made to look equally foolish to comparing gold to a giant lump in the corner. Working with someone whose mother and father bought freedom from Vietnam for their son though the use of the family's gold savings put a definite real world example to me on the potential uses of gold in very hard time.

 

[NW-Bound]

Just because a turd doesn't smell so bad does not make it tastier or any more fit for consumption.

Or is it that many asset classes stink so bad that compared to those, equities smell like roses?

That said, I will never go 100% equities, though one poster seems to do well doing exactly that. I always like to have quite a bit of cash sloshing around, and yes, I count my I-bonds (9% of PF) as cash.

 

[MichaelB]

Or is it that many asset classes stink so bad that compared to those, equities smell like roses? .

Exactly

 

[eytonxav]

I have great respect for Warren Buffet. Nonetheless, he is much more concerned with business risk, while my concern is portfolio sustainability, so I find his view interesting but not useful. Just because equities may prove to hold value better than Treasuries does not make them good investments right now. Just because a turd doesn't smell so bad does not make it tastier or any more fit for consumption.

+1 , now does anyone think if you asked Warren, given his article, whether the average investors should sell their Bonds/FI and move entirely to equity, what do you think he would say?

 

[haha]

This board responds to disturbances from outside just like an automobile shock absorber responds to a bump in the road. The non-compliant idea comes along. If small it is simply ignored, but if from a highly respected, highly successful investor, it is just explained away by posts on why the differeing opinion doesan't matter, is wrong, or does not apply. Or last but not least, I'm sticking with Firecalc and my allocation! Very shortly, it's steady as she goes. Unless of course there is a scary event right in front of our eyes in the markets.

There is a lot more social psychology to learn here than money management.

Ha

 

[Bestwifeever]

...

There is a lot more social psychology to learn here than money management.

Ha

Ain't it the truth. For every post.

 

[Midpack]

I know there are issues with bonds right now. I fully expect to see a 5% or maybe even a 10% haircut on my bond holdings in the next 5 or 10 years as interest rates "normalize". I'm OK with that, as I expect to be able to replenish from my equity funds over time to rebuild the bond portion. And who knows - we might still end up with a super long period with low interest rates and no "normalization". We just don't know.

If that's the extent of the downside, I can certainly live with that risk. And that's presumably based on normal historic interest rates and bond yields. I realize if we have hyperinflation and Carter era interest rates, it will be a lot worse...but that's not what I'm going to plan on.

 

[Bestwifeever]

Seriously, an interesting article. Realistically, not changing our conversative asset allocation for it.

 

[haha]

Ain't it the truth. For every post.

Touché!

 

[bamsphd]

Warren Buffett: Why stocks beat gold and bonds - The Term Sheet: Fortune's deals blog Term Sheet
Our working level for liquidity is $20 billion; $10 billion is our absolute minimum.

After extensive analysis of my personal situation, I have decided that my [-]working level for liquidity[/-] multiple year emergency fund can be less than $10 billion. However, after satisfying my [-]personal liquidity level[/-] cash and short-term bond allocation, and after purchasing my [-]corporate headquarters[/-] house, I have decided to continue investing the remaining 60% of my liquid portfolio in equities via broad index funds.

 

[NW-Bound]

For what it's worth, there's a recent book out that said that "Buffet invests like a girl".

Synopsis: Women are more level-headed than men, and make better investors!

 

[audreyh1]

Warren Buffett: Why stocks beat gold and bonds - The Term Sheet: Fortune's deals blog Term Sheet
Our working level for liquidity is $20 billion; $10 billion is our absolute minimum.

After extensive analysis of my personal situation, I have decided that my [-]working level for liquidity[/-] multiple year emergency fund can be less than $10 billion. However, after satisfying my [-]personal liquidity level[/-] cash and short-term bond allocation, and after purchasing my [-]corporate headquarters[/-] house, I have decided to continue investing the remaining 60% of my liquid portfolio in equities via broad index funds.

This was very cute.

 

[HFWR]

If my portfolio had a "B" handle, I doubt I'd give much thought to my investments, other than how to spend more...

 

[Midpack]

I enjoyed reading these too...I'm staying the course (wasn't in doubt) and feeling better about it.

Fears of Soaring Rates are Overblown (Part 1 of 2)
Fears of Soaring Rates are Overblown (Part 2 of 2)

 

[GRambler]

I have quite a few AAA bonds and 3 Blue Chips.
The blue chips showed more losses than the Bonds this past year.

 

[audreyh1]

I enjoyed reading these too...I'm staying the course (wasn't in doubt) and feeling better about it.

Fears of Soaring Rates are Overblown (Part 1 of 2)
Fears of Soaring Rates are Overblown (Part 2 of 2)

I read those two articles about a month ago. I thought they were really good.

Audrey

 

[NW-Bound]

From the following concluding paragraphs of Rick Ferri's article,

Individual bonds and bond mutual funds are going to deliver a punch sometime in the next few years, but it won’t be a deadly blow. I don’t have a good answer for what is coming, except to say that broad diversification helps, and don’t fight the Fed by trying to predict the timing of their balance sheet unwinding. We’re prepared to muddle through a difficult bond market in the same way we’ve been muddling through a difficult stock market since 2007 – diversify, rebalance, and stay the course.

Fed Chairman Ben Bernanke and the FOMC will likely begin unwinding their balance sheet in a slow and controlled manner starting around 2014. The process will reduce the total return of every bond portfolio over the next decade whether an investor holds individual bonds or mutual funds. Think of it as giving back gains that we should have never earned. On the positive side, I don’t believe rates will soar during the unwinding. This should make the reversal somewhat palatable, whenever it comes.​

I get the notion that he said that bonds and Treasuries performance will most likely to be lousy, and the only question is how lousy it is going to be. Note the sentence that I bolded above. So, if there is not likely to be any upside left, then what's the point? It must be for diversification, just for the sake of it.

I have a bit of I-bonds, which offer superior protection. As I have only a little in some bond funds now, I see no compelling reason for me to get more. In fact, I am still undecided, but at this point do not see that dividend-paying stodgy stocks would be riskier than these bond funds. But that is of course just me.

 

[Midpack]

From the following concluding paragraphs of Rick Ferri's article,

Individual bonds and bond mutual funds are going to deliver a punch sometime in the next few years, but it won’t be a deadly blow. I don’t have a good answer for what is coming, except to say that broad diversification helps, and don’t fight the Fed by trying to predict the timing of their balance sheet unwinding. We’re prepared to muddle through a difficult bond market in the same way we’ve been muddling through a difficult stock market since 2007 – diversify, rebalance, and stay the course.

Fed Chairman Ben Bernanke and the FOMC will likely begin unwinding their balance sheet in a slow and controlled manner starting around 2014. The process will reduce the total return of every bond portfolio over the next decade whether an investor holds individual bonds or mutual funds. Think of it as giving back gains that we should have never earned. On the positive side, I don’t believe rates will soar during the unwinding. This should make the reversal somewhat palatable, whenever it comes.​

I get the notion that he said that bonds and Treasuries performance will most likely to be lousy, and the only question is how lousy it is going to be. Note the sentence that I bolded above. So, if there is not likely to be any upside left, then what's the point? It must be for diversification, just for the sake of it.

Articles and posts that bemoan the outlook for bonds have been a dime a dozen in the past few years. We all know when interest rates rise, and they will eventually, bonds will be impacted. However, Ferri goes on to attempt to quantify the impact in the last few paragraphs in his articles, which puts his articles head and shoulders above all the chicken little pieces IMO. To be fair, you might have acknowledged his attempt to actually offer specific projections. Getting 'killed on bonds' is nothing like 'getting killed on equities' - helps to have someone put that in perspective. YMMV

 

[Hamlet]

The problem is, his specific projections assume that inflation never gets above 2%.

The ten year treasury currently yields 2%.

Say inflation gets to 4% (last year it was 3.5%), and that people return to demanding a 1% real return, so the nominal yield moves to 5% (they were at that level only 5 years ago).

What kind of loss does that generate?

It's about a 30% drop from current prices.

He's putting forth a fairly likely outcome, not a particularly bad one.

Getting killed in bonds actually can be just like getting killed in stocks.

Will it happen? No idea, but bonds aren't paying enough to take that risk.

Articles and posts that bemoan the outlook for bonds have been a dime a dozen in the past few years. We all know when interest rates rise, and they will eventually, bonds will be impacted. However, Ferri goes on to attempt to quantify the impact in the last few paragraphs in his articles, which puts his articles head and shoulders above all the chicken little pieces IMO. To be fair, you might have acknowledged his attempt to actually offer specific projections. Getting 'killed on bonds' is nothing like 'getting killed on equities' - helps to have someone put that in perspective. YMMV

 

[Midpack]

So what's your probable outlook and resulting plan?

 

[Hamlet]

I don't have a crystal ball, and my plan will be different from yours in any event.

I am at least 10 years away from retirement (probably 15), and I have always been comfortable with 100% equities. That is what I have right now, outside of my large emergency fund. As I get closer to retirement, I will consider adding bonds if they appear to be priced to give a positive real return.

If volatility bothered me more, I would add cash and bonds, but I would tilt the bonds toward the shorter end of the yield curve. I would consider I-bonds as well. The one thing I would avoid is having a large percentage of long-dated treasuries. I consider those as risky as stocks currently, without the potential upside.

So what's your probable outlook and resulting plan?