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Below we explain some interesting tidbits Warren Buffett has shared over the years.
Warren is known as one of the greatest investors of all time,
and he has a knack for picking out interesting information and explaining it clearly.
We plan to add sections to this article periodically.
Interest rates and the rear-view mirror
The information in this section is from a presentation Warren gave to to business leaders in 1999.
The presentation was described in a Fortune article behind a paywall.
In this presentation, Warren broke the prior 34-year period into two 17-year periods:
Dec. 31 1964 to Dec. 31 1981 and Dec. 31 1981 to Dec. 31 1998.
Relevant information from these periods is in the table below.
| Date | DJIA | GNP | Interest Rate |
|---|
| Dec. 31 1964 | 874.1 | 1x | 4.2% |
| Dec. 31 1981 | 875.0 | 3.73x | 13.7% |
| Dec. 31 1998 | 9181.4 | 6.60x | 5.1% |
Notice that the Dow (DJIA) failed to grow in the first period, but returned well over 1,000% in the second!
You might guess the US economy didn’t progress in the first period, but you’d be wrong.
The GNP actually grew more than twice as fast in the first period as it did in the second, as can be seen from the table.
What’s Buffett’s takeaway?
He justifies this massive difference in stock returns over the two periods with two economic variables,
along with the emotional swings that exaggerate price movements (fear when things have gone bad,
FOMO when things have done well).
The first variable is interest rates.
As shown in the table, they increased substantially in the first period, but decreased in the second.
Warren explains that interest rates act like gravity on all asset prices including stocks, farmland, and oil reserves.
As rates increase, the present value of future earnings decrease, and hence stocks and bonds fall.
The other variable is valuations—how much investors are willing to pay for earnings.
Poor corporate profits in the first period led to low expectations for future profits.
High interest rates meant those small future profits were worth even less at the time.
The soaring GNP in the first period was countered by plummeting valuations.
In the second period, both phenomena reversed.
Furthermore, investor euphoria blew a bubble that popped shortly after the end of the second period.
Buffett went on to explain that this boom/bust cycle is fueled by investors being guided by the rear-view mirror.
Rather than seeing bargains after a crashed market, investors fear a continuation of the recent pain.
Instead of seeing sky-high prices after a bull run, investors fear they will miss out on further gains.
Why stocks beat bonds
This is an excerpt from Buffett’s 2011 annual letter to shareholders.
All of these letters are free to download and read from
Berkshire’s website.
First, Buffett defines investing as forgoing consumption now to have the ability to consume more in the future.
In other words, setting aside money that, after inflation and taxes,
will grow to have more purchasing power in the future (a positive, real return after taxes).
Given this definition, Warren defines a risky investment as one that’s more likely to
lose purchasing power over the holding period, after taxes.
He contrasts this to the usage of beta for measuring risk—beta is heightened by short-term volatility
that may be meaningless to the long-term investor.
From this view, Warren points out that money-market funds, bonds, and bank deposits are
very risky (despite having low beta).
These assets have shrunk in purchasing power many times,
and he believes this will continue indefinitely as governments naturally gravitate
toward inflationary policies (again, this was written in 2011-2012).
In the US, where stable currency was traditionally kept as a top priority,
the dollar still lost 86% of its purchasing power from 1965 to 2012 (the time of his writing).
In that period, maintaining rolling US treasury bills would’ve returned 5.7%.
However, at an average tax rate of 25%, no purchasing power would’ve accrued over those 47 years!
Of that 5.7% return, 1.4 points were taken annually by explicit taxes, and the
remaining 4.3 points were taken by the often underestimated “inflation tax.”
Of course, during the COVID pandemic (after Warren’s letter) this got much worse
as inflation soared with very low treasury bill rates.
(In the early 1980s interest rates did compensate investors for the risk of inflation,
but most of the time this is NOT the case. )
In 2012 Buffett quoted Shelby Davis: “bonds promoted as offering risk-free returns
are now priced to deliver return-free risk.”
Why stocks beat gold
This was also taken from Buffett’s 2011 annual letter to shareholders.
Again, all of these letters are free to download and read from
Berkshire’s website.
In this letter Buffett made a comparison that’s been discussed many times since.
The world’s gold stock at the time was 170,000 metric tons.
If you melded it together it’d be a cube, 65 feet per side, worth $9.6 trillion.
He visualized this sitting comfortably within a baseball stadium.
Buffett pointed out that, with this $9.6 trillion one could instead buy all
U.S. cropland, 16 Exxon Mobiles, and have a $1 trillion left over.
He asks readers to imagine, over 100 years, all food that farmland would produce,
all the oil the companies would extract and sell, all the assets they’d obtain, ….
Of course, after the 100 years, the owner of the farmland, shares of Exxon Mobiles,
and all the assets accumulated thereby would still own all this.
Meanwhile, that block of gold would produce exactly nothing.
It would still be there, looking the same as ever.
It seems preposterous to think that block of gold would be a better investment.
Gold investors may point out here that it has some industrial and decorative utility.
However, it's industrial/decorative value is a small fraction of $9.6 trillion.
He points out that non productive assets, like gold, require an ever-increasing pool of buyers to hold value.
Since it doesn’t create value, you’ll need favorable supply and demand aspects of the market when you sell, compared to when you bought.
While this may happen, it’s extremely unreliable and amounts more to gambling than investing.
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