I do a fair amount of writing about financial planning; this weekly column, but also for various industry publications and Internet forums. So I usually have a few half-finished articles in the pipeline.
Today I’m going to talk about true wisdom. Coincidentally, as I started in on this week’s column, I came across a half-finished column that I had kind of forgotten about. That work in progress ties in nicely with today’s column about true wisdom, because that other one is going to be about the antithesis of true wisdom.
The impetus for that half-forgotten column was a letter to the editor that I felt compelled to write following the latest butchering of an insurance discussion from someone clearly outside his circle of competence. In the subject line I wrote “Please quit using uninformed people as sources for your stories."
You see, as a consumer of financial journalism, you are going to hear a lot of things from a lot of people. And some things that you will hear are going to be coming from uninformed people who really should stay within their circle of competence, even if they do offer up catchy sound-bites.
On the other hand, there is Warren Buffett. He’s the World’s Greatest Investor, and he just released his annual letter to Berkshire Hathaway shareholders. If there is ever any difference of opinion on financial matters, you’d do well to side with Buffett. He offers true wisdom.
There are three excerpts from this year’s annual letter that I want to share with you; the shape of the U.S. economy, how investors should view their investments, and the prospects for various investments over the long term.
On the status of the U.S. economy, Buffett says, “The steady and substantial comeback in the U.S. economy since mid-2009 is clear from the earnings (of the many companies that Berkshire Hathaway owns)… In short, when you look at Berkshire, you are looking across corporate America.”
Excluding four housing-related companies, “Berkshire’s multiple and diverse non-housing operations earned $1,831 million in 2009, $3,912 million in 2010 and $4,387 million in 2011… illustrating the comeback of much of America from the devastation wrought by the 2008 financial panic. Though housing-related businesses remain in the emergency room, most other businesses have left the hospital with their health fully restored.”
Buffett recently bought a significant stake in IBM, a company that is repurchasing its own shares. On this, Buffett says, “This discussion of repurchases offers me the chance to address the irrational reaction of many investors to changes in stock prices. When Berkshire buys stock in a company that is repurchasing shares, we hope for two events: First, we have the normal hope that earnings of the business will increase at a good clip for a long time to come; and second, we also hope that the stock underperforms in the market for a long time as well.”
“Our quiz for the day: What should a long-term shareholder, such as Berkshire, cheer for during that period?”
“I won’t keep you in suspense. We should wish for IBM’s stock price to languish throughout the five years. The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day’s supply.”
Regarding different investment options, Buffett says, “Investment possibilities are both many and varied. There are three major categories, however, and it’s important to understand the characteristics of each. So let’s survey the field.”
“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 the 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.”
“Right now bonds should come with a warning label. Today, 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.’”
“The second major category of investments involves assets that will never produce anything, but that are purchased in the buyer’s hope that someone else – who also knows that the assets will be forever unproductive – will pay more for them in the future.”
“This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce – it will remain lifeless forever – but rather by the belief that others will desire it even more avidly in the future.”
“The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.”
“As ‘bandwagon’ investors join any party, they create their own truth – for a while. Over the past 15 years, both Internet stocks and houses have demonstrated the extraordinary excesses that can be created by combining an initially sensible thesis with well-publicized rising prices. But bubbles blown large enough inevitably pop. And then the old proverb is confirmed once again: ‘What the wise man does in the beginning, the fool does in the end.’”
“Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce – gold’s price as I write this – its value would be $9.6 trillion. Call this cube pile A.”
“Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?”
“Beyond the staggering valuation given the existing stock of gold, current prices make today’s annual production of gold command about $160 billion. Buyers – whether jewelry and industrial users, frightened individuals, or speculators – must continually absorb this additional supply to merely maintain an equilibrium at present prices.”
“A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops – and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons).”
“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.
Admittedly, when people a century from now are fearful, it’s likely many will still rush to gold. I’m confident, however, that the $9.6 trillion current valuation of pile A will compound over the century at a rate far inferior to that achieved by pile B.”
“My own preference – and you knew this was coming – is our third category: investment in productive assets, whether businesses, farms, or real estate. Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment. Farms, real estate, and many businesses such as Coca-Cola, IBM and our own See’s Candy meet that double-barreled test.”
“Whether the currency a century from now is based on gold, seashells, shark teeth, or a piece of paper (as today), people will be willing to exchange a couple of minutes of their daily labor for a Coca-Cola or some See’s peanut brittle. In the future the U.S. population will move more goods, consume more food, and require more living space than it does now. People will forever exchange what they produce for what others produce.”
“I believe that over any extended period of time this category of investing will prove to be the runaway winner among the three we’ve examined. More important, it will be by far the safest.”
You can read the annual shareholder letter at www.berkshirehathaway.com.
The opinions expressed are those of Brad Brain, CFP, R.F.P. CLU, CH.F.C., FCSI. Brad Brain is a Senior Financial Advisor with Manulife Securities Incorporated, in Fort St John, BC. Manulife Securities Incorporated is a Member of the Canadian Investor Protection Fund. Brad Brain can be reached at firstname.lastname@example.org or www.bradbrainfinancial.com.