Warren Buffett recently penned an interesting article for Fortune Magazine, discussing his thoughts on why stocks present a better long-term opportunity than gold or bonds. The article was such a gem because it provides great insight into Buffett’s way of thinking about investments. His point in a nutshell is this: the most important element of a sound investment is its ability to enable the owner to maintain long-term purchasing power (i.e., stay ahead of inflation).
He also points out that the “risk” of an investment should not be measured by its volatility, but rather by the probability that it fails to maintain or increase purchasing power over the expected holding period. This is not the way most people look at investments.
He believes owning stocks of quality, dividend-paying businesses (both public and private) are the best way to achieve the objective of maintaining long-term purchasing power. Gold can’t do this because it does not produce anything, such as a cash dividend. Bonds can’t do it now because of the fixed nature of their cash flows and very low returns currently. Therefore, to Buffett, stocks offer the “safest” investment because they have the highest likelihood of delivering returns that will maintain or increase the owner’s long-term purchasing power.
For financial planners, Buffett’s concept of investing has important implications. One of the most important objectives in planning and investing for clients is maintaining purchasing power over long periods — in many cases, decades. We do this through owning equities (common stocks), just as Buffett points out, because they deliver the elements important in maintaining purchasing power. We also invest in stocks because they are highly liquid and provide flexibility in customizing and fine-tuning portfolio investments and providing adequate diversification. Another important aspect of Buffett’s philosophy is the need to plan and think for the long-term. By thinking long-term, as Buffett does, the client has a much-improved chance of achieving his/her financial goals and mitigating the impact of short-term market fluctuations.
We would hasten to point out, however, that as financial planners, we do believe bonds and commodities, such as gold, play an important role. Why? Because these assets have low correlations with stocks and thereby offer the benefits of diversification. By incorporating stocks and bonds together in a diversified portfolio, you can provide the growth necessary for a successful plan, while reducing the volatility of the portfolio.
Bob Toomey is vice president, research, with S.R. Schill & Associates, a financial planning and investment firm located on Mercer Island.
