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Bonds: The Riskiest Investments of All

It is generally wise to fight the desire to seek out opinions that align with your own beliefs (confirmation bias), but sometimes it is a bit reassuring to have a respected investor in your camp.  In a piece written by Warren Buffett for Fortune magazine, Buffett calls out the fallacy of conventional “safe haven” wisdom:

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 these 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 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.”

Proof to that statement is the purchasing power of the US dollar, expressed with 1967 as 1 Dollar:

My personal favorite quote is from Shelby Cullom Davis, “Bonds promoted as offering risk-free returns are now priced to deliver return-free risk.”

The article is definitely worth a read for gold bugs, bond buyers and those sitting in cash. My own view is that single family houses present the highest return opportunity today.

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  1. Friday 7atSeven: productive assets | Abnormal Returns linked to this post on February 10, 2012

    […] Warren Buffett prefers productive assets.  (Kid Dynamite, SurlyTrader, Ivanhoff […]

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