World Economy

Mistake for Long-Term Investors to Be in Bonds

High-grade bonds can increase the risk of an investment portfolio as inflation eats away at the return
The New York Stock ExchangeThe New York Stock Exchange

Billionaire Warren Buffett prodded ordinary investors on Saturday to stay invested in US stocks, ignoring price swings, guidance from people with fancy credentials and the temptation to load up on bonds.

Buffett said it is a "terrible mistake" for investors with long-term horizons—among them, pension funds, college and endowments and savings-minded individuals—to measure their investment "risk" by their portfolio's ratio of bonds to stocks, Reuters reported.

The long-time bull on US companies and the economy issued his latest letter to Berkshire Hathaway Inc shareholders on Saturday.

Treasury yields have been rising since the start of the year, stemming from brewing inflationary pressures and massive bond supply to help fund US President Donald Trump's tax overhaul.

Higher rates have kept US equity markets under selling pressure, as investors worry borrowing costs could hurt companies' profitability. Earlier this month, stocks suffered their first 10% pullback since early 2016.

High-grade bonds, he said, can increase the risk of an investment portfolio as inflation eats away at the return.

"There is simply no telling how far stocks can fall in a short period," Buffett said. "As an investor's investment horizon lengthens, however, a diversified portfolio of US equities becomes progressively less risky than bonds, assuming that the stocks are purchased at a sensible multiple of earnings relative to then-prevailing interest rates."

Long Bull Market

Buffett said Berkshire is sitting on $116 billion of low-yielding cash and government bonds—whose average maturity was 88 days as of year-end 2017. They are struggling to put that money to work because of a "purchasing frenzy" by deal-hungry chief executives employing cheap debt that pushed "prices for decent, but far from spectacular, businesses" to "an all-time high".

Known to fans as "the Oracle of Omaha," Buffett, 87, has suggested US stocks are probably the best bet over time, encouraging people to make easy choices and stick with them, eschewing high-fee fund managers, for instance.

In 2014, Buffett said he plans to put 90% of the money he leaves to his wife, Astrid, when he dies into an S&P 500 index fund, and 10% in government bonds.

Buffett in 2007 bet a founder of the asset management company Protege Partners LLC $1 million that a Vanguard S&P 500 index fund would outperform several groups of hedge funds over a decade. He won that bet last year. The proceeds were given to Buffett's charity of choice, Girls Inc of Omaha.

Yet his own unease with market prices comes as other investors have struggled with the same problem after a near-decade long bull market.

"Though markets are generally rational, they occasionally do crazy things," said Buffett, adding that investors need "an ability to both disregard mob fears or enthusiasms and to focus on a few simple fundamentals" even if makes them "look foolish."

"In America, equity investors have the wind at their back," he said.

In early February, Morgan Stanley estimated Berkshire has enough cash on hand, and generates enough cash flow, to do a deal exceeding $160 billion. As for which industry Berkshire may pursue, UBS thinks utilities are a good bet. After all, the company's energy unit made an unsuccessful $9 billion offer for the electricity provider Oncor last year and may still be interested in the sector.

So why is it so hard to find a good, attractively-valued company? Buffett at least partially attributes the difficulties he's facing to the "can-do" nature of corporate executives, who he says "never lack for forecasts that justify" deals at lofty valuations. He also cited the continued availability of cheap debt, while noting Berkshire prefers to conduct its acquisitions strictly in equity.

Surge in Bond Yields

A surge in bond yields that sent stock markets skidding from record highs this month may have ripple effects outside Wall Street, as home ownership costs rise and nest eggs shrink, Reuters reported.

While investors felt the brunt of a slide of more than 1,000 points in the Dow in recent weeks, before it recovered most of the losses, consumers have started to feel the pinch of rises in interest rates that are closely linked to the bond market.

Banks and lenders, whose own borrowing costs have risen, are charging consumers more on mortgages, some of which are at their highest rates in four years, and other loans tied to the bond yields.

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