Five investment tips from Warren Buffett

There is no such thing as a safe-haven asset

Warren Buffett, chairman of Berkshire Hathaway, says that anyone who turns their back on equities because they fear losing money doesn’t understand the impact of inflation.

"In the US, the dollar has fallen a staggering 86 per cent in value since 1965," he explained. "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 per cent 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."

When the effect of tax is added to the mix, the results are even more conclusive.

"During the same 47-year period, continuous rolling of US Treasury bills produced 5.7 per cent annually," Buffett continued. "That sounds satisfactory. But if an individual investor paid personal income taxes at a rate averaging 25 per cent, this 5.7 per cent 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 stated yield, and the invisible inflation tax would have devoured the remaining 4.3 points."

"A wry comment that Wall Streeter Shelby Cullom Davis made long ago seems apt: 'Bonds promoted as offering risk-free returns are now priced to deliver return-free risk.'"


Beware of fool’s gold

Buffett points out that gold’s major attribute is its use as a safe-haven asset, meaning anyone speculating on its value to increase is relying on the ranks of the fearful to grow. While he admits that these speculators have been proven right over the past 10 years or so, the appreciation in value of what is in essence a useless material has all the hallmarks of a bubble.

Today the world’s gold stock is about 170,000 metric tons, which at $1,750 per ounce means it is worth $9.6trn.

For that price, Buffett says: "We could buy all US cropland (400m acres with output of about $200bn annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40bn annually). After these purchases, we would have about $1trn left over for walking-around money (no sense feeling strapped after this buying binge)."

The effect of compounding income means a century from now the Exxon dividends would be almost too enormous to calculate, ditto the amount of crops produced. Meanwhile, Buffett warns: "The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond."


The developed world story is far from over

Buffett says: "In total, our entire string of operating companies spent $8.2bn for property, plant and equipment in 2011, smashing our previous record by more than $2bn. About 95 per cent of these outlays were made in the US, a fact that may surprise those who believe our country lacks investment opportunities. We welcome projects abroad, but expect the overwhelming majority of Berkshire’s future capital commitments to be in America. In 2012, these expenditures will again set a record."

He thinks the US property sector in particular will soon return to the glory days, saying: "Demographics and our market system will restore the needed balance – probably before long. When that day comes, we will again build one million or more residential units annually. I believe pundits…will then reawake to what has been true since 1776: America’s best days lie ahead."


Look at the bigger picture

Buffett and Charlie Munger, Berkshire’s vice chairman, measure their performance against that of the S&P 500, and Buffett claims: "If our gain over time outstrips the performance of the S&P 500, we have earned our paychecks. If it doesn’t, we are overpaid at any price."

Despite this, he is happy to underperform for more than a year at a time, especially during market rallies, so long as this falls within a longer period of outperformance. He says: "We’ve regularly emphasized that our book-value performance is almost certain to outpace the S&P 500 in a bad year for the stock market and just as certainly will fall short in a strong up-year. The test is how we do over time."

In the 42 five-year periods since Buffett took over at Berkshire in 1965, and in 2007 to 2011, he has beaten his S&P 500 benchmark.


Everyone makes mistakes

While every investor with more than a few years’ experience will be familiar with the stomach-churning feeling of watching a market slump wiping a large chunk off the value of their portfolio, there must be few – the UK’s bankers aside – who have lost more due to a single decision than Buffett.

"A few years back, I spent about $2bn buying several bond issues of Energy Future Holdings, an electric utility operation serving portions of Texas," he explained.

"That was a mistake – a big mistake. In large measure, the company’s prospects were tied to the price of natural gas, which tanked shortly after our purchase and remains depressed."

Buffett wrote down the value of the investment by $1bn in 2010 and by an additional $390m last year. Although Berkshire has received interest payments of about $102m since this purchase, Buffett says that unless the price of natural gas increases, "We will likely face a further loss, perhaps in an amount that will virtually wipe out our current carrying value. I totally miscalculated the gain/loss probabilities when I purchased the bonds. In tennis parlance, this was a major unforced error by your chairman."