According to Fortune Magazine, Warren Buffett, the Oracle from Omaha, will soon release his annual shareholder letter pointing out that “money-market funds, bonds, mortgages, bank deposits…are thought of as ‘safe.’ In truth they are among the most dangerous of assets…their risk is huge.”
Further in the letter, Mr. Buffet writes that “Right now bonds should come with a warning label.” Why is Mr. Buffett so concerned about these types of investments, many of which are embraced by retirees in their search for a safe haven for their IRAs and 401(k)s?
According to Mr. Buffett, the answer is clear. “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.”
To put it another way, with interest rates at record lows, and with the Federal Reserve taking steps to keep interest rates from rising until sometime in 2014, retirees risk the loss of purchasing power through the creep of inflation.
Look at how the cost of gasoline is rising? How about the cost of groceries? Does anyone really expect the true cost of living not to increase? So the retiree gets his or her monthly check, but what that check buys each month diminishes from one year to the next.
True, we use bonds in our portfolios. Not the long term bonds to which Mr. Buffett refers, but primarily short term bonds which, by the way, Mr. Buffet states that his company, Berkshire Hathaway, also hold in “significant amounts.”
We use these types of bonds not to generate a significant income for our clients, but as a stabilizer to keep the wild swings out of our clients’ investment experience. The amount of these types of bonds that we use varies accordance to each client’s risk tolerance.
So what is the solution that preserves purchasing power? What should most investors hold? The answer, especially for retirees and those preparing to retire, is a properly allocated stock portfolio heavily diversified over all of the major asset classes, and moderated by the proper amount of short term bonds.
Or as Fortune Magazine interprets Mr. Buffett, “Equities almost always beat the alternatives over time.” Take a look at the 1 1/2 minute video from Bloomberg linked below. I think you will enjoy it.